Learn what the best choice is for your retirement future if you are a single employee at your company or you are a small company considering whether an SEP-IRA or a SOLO 401k is your best choice …
If you operate a small company or you are a single person owner–you may be deciding among a number of retirement plans to stash away money for your retirement years. Trying to decide the best option can be a daunting task for those who are new at facing retirement options or have recently opened a business for the first time.
In this discussion TheWealthIncreaser.com will present ways that you can make this sometimes grueling decision—less grueling and help put you on a path to enjoying your retirement in the manner that you desire and provide you with more clarity so that anxiety will not play a role in your life as you build wealth for yourself and your family.
It is the desire of TheWealthIncreaser.com that you will use this page as a guide so that you can experience joy on the inside that will lead to your retirement portfolio and your conscience experiencing a smoother ride!
Retirement Plan Options:
Depending on your line of work there could be many retirement options available to you.
Some of the more common include IRA’s (many versions), 401k’s, 403b’s, SIMPLE IRA Plans (Savings Incentive Match Plans for Employees), SEP Plans (Simplified Employee Pension), SARSEP Plans (Salary Reduction Simplified Employee Pension), Payroll Deduction IRAs, Thrift Plans, RRB Plan (Railroad retirement Benefits Plan), Traditional Pension such as Defined Benefit Plans, Money Purchase Plans, ESOPs (Employee Stock Ownership Plans), Government Plans, 457 Plans, 409A Non-qualified Deferred Compensation Plans and other profit sharing options.
If you desire a more in-depth understanding of the various retirement types or you feel that a SEP-IRA or a SOLO 401k is not right for you—consider going to the following links to learn more about the retirement account that may be a better choice for you.
If you are a small operator, depending on your yearly income—you could be choosing among a number of options but in the end the choice of which “Retirement Plan Option” is best for most and possibly you as well—normally comes down to the choice between an SEP-IRA versus SOLO 401k as they both allow you to maximize your contribution limits and control your investment options better than other plans.
However, as a practical matter it is important that you look at and appropriately analyze all options available to you and not just base your decision on how you feel or think or based on what others are doing.
You must analyze all retirement options to see where you will benefit most from a revenue, savings, tax and goal oriented perspective. After thorough analysis (and possible professional advice) you can select a retirement vehicle that serves your future goals and allow you to maximize your savings and tax advantages on an annual basis.
A SEP-IRA allows you to make contributions that are capped at 25% of your income after a reduction for self-employment taxes. A SEP-IRA is used by those who have a small firm and solo entrepreneurs as well.
SEP IRA contributions for sole proprietors, on the other hand, are limited to 20% of your net self-employment income (business income minus half of your self-employment tax), up to a maximum contribution of $54,000 for 2017.
SEP Contribution Limits (including grandfathered SARSEPs) controls what an employer can contribute to an employee’s SEP–IRA. The amount cannot exceed the lesser of 25% of the employee’s compensation, or $53,000 (for 2015 and 2016, $54,000 for 2017).
Example: Lets say you are 52 years old and earned $60,000 in income after receiving your w-2 from your Limited Liability Corporation business in 2017.
Your total contributions would be capped at $15,000 for 2017!
If you earned $144,000 your contributions would be capped at $36,000.
If you earned the maximum income for the year $270,000, your contributions to the SEP-IRA would be capped at $54,000. The reason being that you have exceeded the contribution limit.
Can I make catch-up contributions to my SEP-IRA?
Because SEP IRA’s are funded by employer contributions only, catch up contributions usually don’t apply because you as an owner (employer) would be making the contributions.
Catch-up contributions apply only to employee elective deferrals.
However, if you are permitted to make traditional IRA contributions to your SEP-IRA account, you may be able to make catch-up IRA contributions.
Compensation doesn’t include amounts deferred under a Section 125 cafeteria plan.
Compensation is limited to $270,000 in 2017 and $265,000 in 2015 and 2016.
A SOLO 401k allows you to stash away up to $18,000 in 2016 and 2017, or $24,000 in 2016 and 2017 if age 50 or over.
In addition, you can also use SOLO 401k’s to make ROTH 401k deferrals of after-tax money that you can withdraw tax free during your retirement years.
A Solo 401(k), (also known as a Self Employed 401(k) or Individual 401(k)), is a 401(k) qualified retirement plan that was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse(s).
A one-participant 401k also goes by other names, such as solo-k, Uni-k, one participant k and possibly other names as well as they are becoming more popular.
Although unknown by many in the general public a one-participant 401(k) has been around for a while (early 2000’s) and is basically a plan covering a business owner with no employees or just their spouse–and have the same rules and requirements of any 401(k) plan!
Contribution limits in a one-participant 401(k) plan
In a SOLO 401(k) plan the business owner (you) are both employee and employer.
You must always realize that contributions can be made to the plan in both capacities and you as the owner can contribute both:
- Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit of $18,000 in 2016 and 2017, or $24,000 in 2016 and 2017 if age 50 or over; plus
- Employer non-elective contributions up to 25% of compensation as defined by the plan
For self-employed individuals:
Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $54,000 (for 2017; $53,000 for 2016)
Example: Lets say you are 52 years old and earned $60,000 in W-2 wages from your S Corporation in 2017. You deferred $18,000 in regular elective deferrals plus $6,000 in catch-up contributions to the 401(k) plan.
Your business contributed 25% of your compensation to the plan, $15,000.
The total contributions to your plan for 2017 that would be allowed is $39,000 with your maximum contribution for the year being $60,000 “if” you earned $144,000 in 2017 ($144,000 * .25 plus $24,000).
This would be the maximum that you could contribute to the plan for Tax Year 2017.
If you had income from other sources and you participated in another 401(k) plan–your deductions would not be allowed and you would have to take corrective action. By reading this discussion you now know that your limits on elective deferrals are by person, not by plan–meaning once you reach the limit–that’s it!
In essence, you must consider “the limit” for “all elective deferrals that you makes during a year”–regardless of source to ensure that you don’t exceed the limits and have to take corrective action–that could get costly!
Contribution limits for self-employed individuals
You must make a special computation to figure the maximum amount of non elective (25% of your earned income) and elective ($18,000 in 2016 and 2017, or $24,000 in 2016 and 2017 if age 50 or over) contributions that you can make for yourself.
When figuring the contribution, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both:
- one-half of your self-employment tax, and
- contributions for yourself.
Testing in a one-participant 401(k) plan
A business owner with no common-law employees doesn’t need to perform nondiscrimination testing for the plan, since there are no employees who could have received disparate benefits.
The no-testing advantage vanishes if the employer hires employees. No matter what the 401(k) plan is called by a plan provider, it must meet the rules of the Internal Revenue Code.
If you hire employees and they meet the plan eligibility requirements, you “must include them in the plan” and their elective deferrals will be subject to nondiscrimination testing (unless the 401(k) plan is a safe harbor plan or other plan exempt from testing).
A one-participant 401(k) plan is generally required to file an annual report on Form 5500-SF if it has $250,000 or more in assets at the end of the year.
If you are a one-participant plan with fewer assets you may be exempt from the annual filing requirement.
Alternatives to a one-participant SOLO 401(k) plan and SEP-IRA
Other possible plans for a single business owner that might work for you depending on your business revenue and future goals include:
With a SOLO 401k you could contribute up to $54,000 for 2017 with a $6,000 catch-up provision if you are over age 50 (maximum contribution $60,000).
If you desire to establish a SOLO 401k you can go to: http://www.kiplinger.com/article/retirement/T001-C001-S003-set-up-a-solo-401k-with-low-fees.html
If you had annual income of $250,000 with a SEP-IRA you could contribute up to $54,000 for 2017.
If you desire to establish a SEP IRA you can go to: https://www.irs.gov/retirement-plans/establishing-a-sep
Be sure to consider other factors as well such as your years in business, when you plan to exit, tax ramifications now–and in your future, setup fees and administration fees, your anticipated future income, company growth and other factors that may be unique to you or the business that you operate.
You can choose to use an SEP IRA or SOLO IRA if you are a sole proprietor, LLC or Limited Liability Company, S Corporation and possibly other legal structures that meet the IRS guidelines.
As you might expect the SEP IRA was once cheaper to set up and administer, however that has now changed as many brokerage companies offer low cost SOLO-IRA setup and administering. In addition, you must look at more than just setup costs and the administrative fees as those are just a small piece in the overall puzzle toward your retirement goals.
Always keep in mind that SEP IRA contributions for sole proprietors, on the other hand, are limited to 20% of your net self-employment income (business income minus half of your self-employment tax), up to a maximum contribution of $54,000 for 2017.
You may have more investment choices with a SEP IRA as opposed to a SOLO 401k.
With a SOLO 401k you have the 25% employer contribution amount (non-elective deferral) based on your income minus the self-employment taxes–plus the elective deferrals and catch-up provision that would allow you to save more annually than a SEP IRA generally–depending on your income.
With both plans you would have to pay taxes on withdrawals, however at that time you might be in a lower tax bracket. Both plans allow you to use the power of compounding to help you reach your retirement number.
Early withdrawals or tapping into the account by you will result in serious tax penalties and vary depending on your age, years of contributions and whether an exception may apply.
Investments and Withdrawals basically follow the same guidelines that the IRS has set for IRA’s and 401k’s in general!
If you know that you will come out of the gate making $150,000 the decision as to the best choice will be much clearer for you. However, if you come out of the gates slow and steady with your income increasing steadily from a low amount such as $20,000 in year one–$40,000 in year two and a steady upward trend an IRA SEP may serve your best interests during your early years.
In the end “proper analysis” and not just going on what you hear or see others doing –or what you feel will work is the real key. It is the hope of TheWealthIncreaser.com that this discussion has at least provided you a starting point toward making your retirement dreams come true.