For the small business owner, a retirement plan can help reduce taxes and provide cost-effective incentives and benefits to employees, but the available plan options should be understood so that an informed decision is made as to what plan type may be most beneficial.
The SIMPLE IRA – A good option for newer companies with employees. The SIMPLE IRA allows for employees to defer up to $13,000 of income ($16,000 for those age 50 and older). The employer must either match employee contributions up to 3 percent of compensation, or make a flat contribution of 2 percent of compensation; both options are calculated on compensation up to an annual limit of $280,000. The SIMPLE IRA is a great option for newer companies as there are limited costs to start and administer the plan.
The 401(k) Plan – A good option for growing and established companies with employees. The 401(k) plan allows for employees to defer up to $19,000 per year of income ($25,000 for those aged 50 and older). The plan can also allow for tax advantaged Roth deferrals and allow employees the flexibility to take loans. The 401(k) is a flexible and valuable option for employees and employers alike, but there are annual compliance and filing requirements, as well as startup and administration costs.
The SEP IRA – A good option for the high earning self-employed who don’t have employees. The SEP IRA allows for the self-employed to defer a portion of their income (the formula can be a bit tricky) up to a contribution limit of $56,000 for 2019. The IRS publishes the limit on deferrals as the lesser of 25 percent of income or $56,000. However, since the amount of the contribution counts as an expense, the actual effective amount that you can contribute is 20 percent of your income (up to the limit).
The Individual (“Solo”) K – A potentially better option than a SEP IRA for the solo practitioner. The Individual K is a lot like the traditional 401(k) plan offered by employers, but it is reserved for solo practitioners with no employees (other than a spouse). It provides potentially higher and less restrictive contribution limits than the SEP IRA.
Within the Individual K, there are two types of contributions – employee and employer. As an employee, the solo practitioner can defer the lesser of $19,000 ($25,000 for those aged 50 and older) or 100 percent of compensation for 2019. As an employer, additional contributions may be made as a percentage of the company profits.
For a solo practitioner, it is easier to calculate and qualify to make higher contributions to the Individual K than the SEP IRA. In addition to a potentially higher contribution, the Individual K provides more options and flexibility such as the Roth option for tax savvy savers and access to the funds through loans – neither option is available in a SEP IRA.
About the Author
Bradley Bofford is a managing director and partner of Financial Principles, LLC, a HighTower wealth management practice.
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