Years ago, pension plans and other qualified retirement plans were offered only by the “big boys on the block.” But now, many small companies are in the game. In fact, if you are self-employed and you don’t have any employees, you have a number of retirement plan options at your disposal. If you have employees, you still have some good options. Here are five popular choices for self-employed business owners.
1. A SEP Plan
Frequently, a self-employed individual will adopt a Simplified Employee Pension (SEP) plan, which is comparable to a traditional IRA. A SEP isn’t a good plan if you have employees! If you have employees, they must be covered at the same rate you cover yourself. If it’s just you, then you can contribute to the plan based on a percentage of your total compensation, up to the tax law limit. You make the decision to contribute each year; there is no commitment to make annual contributions. For 2018, deductible SEP contributions cannot exceed the lesser of 25% of the employee’s compensation or $55,000. As with all qualified plans, the maximum compensation taken into account in 2018 is limited to $275,000. If you are 50 or above, you can add another $6,000 Catch-Up Contribution.
You do not need to hire a Third Party Administrator to calculate your contributions to a SEP Plan. Therefore, the SEP is easy and inexpensive to manage. You do, however, have to file a 5500 Form each year when you plan balance exceeds $250,000.
The SEP Plan is the main go-to tax planning choice of most CPA’s – but it is not the best choice in my opinion. However, if you didn’t set up another play by 12/31/17 then then SEP may be your best option in 2018 because you have all the way until the due date of your tax return (plus extensions) to set up AND fund the plan.
2. A SIMPLE Plan
A Savings Incentive Match Plan for Employees (SIMPLE) is available only to a business with 100 or fewer employees and no other retirement plan. You, as the employer, must make a matching contribution equal to a certain portion or percentage of each employee’s contribution or a minimum non-elective contribution for all plan participants. For 2018, you can contribute up to $12,500 ($15,500 if age 50 or older) to a SIMPLE. As a further enticement, you do not have to file an annual return 5500 Form the plan. The benefit of the SIMPLE plan is that it does not require the services of a Third Party Administrator to calculate the contributions each year. The drawbacks are that the contribution limits are relatively low and that you have to contribute to employees at the same rate that you contribute for yourself.
3. A Solo 401(k) Plan
These plans may cover a business owner with no employees. The same rules and requirements apply to a Solo 401(k) as for a 401(k) of a large corporation, except there are no employees to be covered or included in the plan. The self-employed person is both employer and employee and they get to contribute in both capacities making the Solo 401k generally a better choice than a SEP.
In 2018, a self-employed person can defer up to $18,500 ($24,500 if age 50 or older) as an employee, ‘elective’ contribution. At the same time, the employer ‘profit sharing’ contribution is also allowed. This employer contribution is calculated the same way the SEP contribution is calculated: it cannot exceed the lesser of 25% of compensation or $55,000 ($61,000 if age 50 or older). Generally, you can get a higher contribution into the Solo 401k Plan than you can with a SEP. However, the Solo 401k Plan must be established by 12/31 of the prior year. The contribution itself can be deposited up to the due date of the tax return plus extensions. There is no obligation from year to year to continue funding the Solo 401k Plan. Therefore, it is just as flexible as the SEP while generally offering higher contribution opportunities.
4. Keogh Plan
These “dinosaur” retirement plans, specifically designed for self-employed individuals, may be considered relics of the past by some, but they are still kicking around. There are two main types: defined contribution Keoghs and defined benefit Keoghs. The basic rules apply for these types of plans, but with a twist: The annual contribution limit is based on “earned income” instead of “compensation” and thus effectively reduces the percentage cap for self-employed individuals. In contrast to a defined contribution plan (e.g., a 401[k]), in 2018, a defined benefit plan may provide an annual retirement benefit equal to the lesser of 100% of earned income for the three highest-paid years or $220,000.
5. Solo Defined Benefit Plan
A Solo Defined Benefit Plan, combined with a Solo 401k Plan is going to give the very high income self-employed person an even higher tax-deductible retirement contribution. This is going to be most effective for older people who are nearing retirement and are in their top earning years. The calculations are complex and will require the services of a Third Party Administrator, but for people who want to maximize their tax-deferred savings, this is an option worth exploring.
We can help you choose the right retirement plan for your business. We investigate all the possibilities and help you choose the right strategy to fit your changing circumstances. Each year, you have a once in a lifetime opportunity to save money on a tax-advantaged basis and we want you to make the most of it.
For more information, you can refer to the Retirement Plan Comparison Chart available on the website: