Written by Chetan Dogra, CPA
I frequently get this question: My son started a business 10 years ago and contributed to a regular IRA in the beginning (we discussed IRAs in the last post). Three years ago, he incorporated the company and they don’t have a 401(k) yet. What’s his best option for retirement and year-end savings right now?
Here is my take:
Solo 401K – Combined tax free contributions $54,000, or $60,000 you are 50 or older
Best for: A sole proprietor who wants to maximize contributions to a tax-deferred retirement plan. But it’s only available if you work for yourself and your only employee is your spouse, so it’s not the best plan for small businesses with expansion plans.
SEP – Max deduction lower of $54,000 or 20% of your adjusted net earnings
,Best for: High-income business owners who want to maximize contributions through an uncomplicated plan with low fees. SEPs also work well for small-business owners with mostly low-paid, high-turnover employees.
Simple IRA – Max deduction $12,500 ($15,500 for 50 or older) plus employer contribution
Best for: Someone with self-employment income particularly from consulting or freelance work of $30,000 or less. There’s no percentage-of-income limit, but actual dollar limits are much lower than for other plans.
401K – Tax benefit and contribution rules are same as solo 401K
Best for: The 401(k) is the most ideal choice for small and big businesses. It helps you attract and retain the best employees, but also may save on taxes.
Defined Benefit Plan
Best for: Although not as commonly used as in the past, a traditional defined benefit pension plan can be ideal for older business owners who wish to accumulate benefits faster than may be possible with other types of plans. Benefits are typically based on average pay and length of service (subject to annual limits).
Contributions for all the above mentioned plans are tax-deductible and earnings are tax-deferred. You’ll pay taxes and, usually, a 10% penalty on early withdrawals.
Remember with these plains, you have saved tax on your seed, but you will owe tax on your harvest and may not be a good choice if you are not in a lower tax bracket in retirement.
Keep in mind that everyone’s tax situation is different, and tax rules can be complex. These tax tips have been prepared for informational purposes only and should not be relied on for tax, legal or accounting advice.
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