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As small business owners become more successful, they look for ways to reduce their tax burden. One of the most popular ways to reduce taxes is with a SEP IRA. This is the most “used” and popular option, one of which is highly recommended by CPA’s. While the SEP IRA is the simplest and easiest to set-up, it does not necessarily provide the best tax advantages.
Certain plans, such as a Solo-401 can provide a better tax benefit without adding any additional cost or complexity. In some cases, a Solo-k can offer much more flexible and “liquidity” to the owner for his/hers business growth, which is just not possible in a SEP.
In some cases, a change to the corporate structure can open additional options as well. You need the right Financial planner and small business retirement specialist who has the right experience and expertise with a proven track record to help guide you through that process. Let AFG, along with the approval from your CPA determine a tax strategy that works for you and your company. Have the small business experts at AFG put a plan in place to help you achieve your current and future goals.
Want more information, please call, or use our contact page for your free consultation today!
Small business owner retirement strategies
1. Traditional or Roth IRA
Best for: Those just starting out or saving less than $6,000 a year. If you are leaving a job to start a business, you can also roll your old 401(k) into an IRA.
IRA contribution limit: Up to $6,000 in 2020, plus a $1,000 catch-up contribution for those 50 or older.
Tax advantage: Tax deduction on contributions to a traditional IRA; no immediate deduction for Roth IRA, but withdrawals in retirement are tax-free.
Employee element: None. These are individual plans. If you have employees, they can set up and contribute to their own IRAs.
2. Solo 401(k)
Best for: A business owner or self-employed person with no employees (except a spouse, if applicable).
Contribution limit: Up to $57,000 in 2020 (plus a $6,000 catch-up contribution for those 50 or older) or 100% of earned income, whichever is less. To help understand the contribution limits here, it helps to pretend you’re two people: An employer (of yourself) and an employee (also of yourself).
In your capacity as the employee, you can contribute as you would to a standard employer- offered 401(k), with salary deferrals of up to 100% of your compensation or $19,500 (plus that $6,000 catch-up contribution, if eligible), whichever is less.
In your capacity as the employer, you can make an additional contribution of up to 25% of compensation.
3. SEP IRA
Best for: Self-employed people or small-business owners with no or few employees.
Contribution limit: The lesser of $57,000 in 2020 ($56,000 in 2019) or up to 25% of compensation or net self-employment earnings, with a $285,000 limit on compensation that can be used to factor the contribution. Again, net self-employment income is net profit less half of your self-employment taxes paid and your SEP contribution. No catch-up contribution.
Tax advantage: You can deduct the lesser of your contributions or 25% of net self-employment earnings or compensation — limited to that $285,000 cap per employee in 2020 — on your tax return. Distributions in retirement are taxed as income. There is no Roth version of a SEP IRA.
There is a special rule for sole proprietors and single-member LLCs: You can contribute 25% of net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself.
The limit on compensation that can be used to factor your contribution is $285,000 in 2020.
4. Simple IRA
Best for: Larger businesses, with up to 100 employees.
Contribution limit: Up to $13,500 in 2020 or $13,000 for 2019 (plus catch-up contribution of $3,000 if 50 or older). If you also contribute to an employer plan, the total of all contributions can’t exceed $19,500.
Tax advantage: Contributions are deductible, but distributions in retirement are taxed. Contributions made to employee accounts are deductible as a business expense.
Employee element: Unlike the SEP IRA, the contribution burden isn’t solely on you: Employees can contribute through salary deferral. But employers are generally required to make either matching contributions to employee accounts of up to 3% of employee compensation, or fixed contributions of 2% to every eligible employee. Choosing the latter means the employee does not have to contribute to earn your contribution. The compensation limit for factoring contributions is $285,000 in 2020.
5. Defined benefit plan
Best for: A self-employed person with no employees who has a high income and wants to save a lot for retirement on an ongoing basis.
Contribution limit: Calculated based on the benefit you’ll receive at retirement, your age and expected investment returns.
Tax advantage: Contributions are generally tax deductible, and distributions in retirement are taxed as income. An actuary must figure your deduction limit, which adds an administrative layer.