So, You Are Self-Employed, Options Beyond the “Traditional”
19 Oct 2016
I get the opportunity to meet many individuals with the entrepreneurial spirit and aid them with their financial planning needs. Typically, when I meet someone who either runs a sole proprietorship or a single member LLC, one of the more frequent questions that we discuss is what their retirement plan looks like. When someone is running a profitable business and wants to make tax deductible contributions to their retirement, they may be frustrated with the limit that the government imposes upon contributions to a Traditional IRA.
Fortunately, there are other alternatives available1. Depending on whether or not they have employees will also affect the decision on the proper retirement plan for them to use. If they have employees and want to provide them an opportunity to save as well, a SIMPLE IRA plan may be the best solution. Couple providing existing employees a benefit with a larger $12,500 with a $3,000 catch up contribution limit for 2016, and this makes a lot of sense for many business owners. While the employer will be required to have either a matching program or an automatic contribution, it will allow them to increase their own retirement contributions beyond the Traditional limits.
If they are self-employed and they are the only employees of the business as well, we may look at a SEP or a Solo 401(k). For 2016, employers can contribute up to 25% of compensation into a SEP up to a maximum of $53,000, while the Solo-401(k) will follow similar guidelines outlined for other employer sponsored defined contribution plans and have a $18,000 employee salary deferral limit with a $6,000 catch up provision for 2016 for individuals that meet the catch up age requirements. Solo-401(k) plans will also allow the employer to match their own contributions as employees, as well as make profit sharing and other types of contributions into the account. The participant can also select to add a Roth option to the 401(k) as well, though only the employee can make contributions into that portion of the plan.
One of the other advantages of these types of plans is that the individual may be able to open a tax deductible Traditional or Roth IRA if their income is within the limits outlined by the IRS. So for example, it is possible for a solopreneur to make the maximum contributions to a Roth IRA, and then put away 15% of their income into a SEP IRA. This will provide a level of flexibility with tax management during retirement, as they will be able to create a stream of both taxable and tax free income.
I suggest discussing with both your financial advisor and tax preparer prior to making any significant decisions. One thing that I have learned is while individuals may have similar situations at the surface, it isn’t until a deep dive into their unique situation is done that their true goals are uncovered and the best recommendation can be made.