Choosing the right retirement plan for your small business is imperative and will enable you to meet your long-term retirement goals. There are multiple plan options available to sole proprietors and single-member LLCs; each type of plans comes with unique stipulations, advantages and disadvantages.
SEP – A SEP, short for “Simplified Employee Pension”, is designed for small-business owners with few or no employees. The contribution limit is the lesser of $56,000 or 25% of compensation or net self-employment earning, with no provision for catch-up contributions over age 50 or a Roth version of a SEP. Additionally, SEP plans only allow for employer contributions and the employer must contribute an equal percentage of salary for each eligible employee; for that purpose, the owner is considered an employee.
If you establish a SEP plan for your self-employment income and have another 401(k) from your employer, your contributions are treated separately. One can therefore defer up to $19,000 of salary in addition to the employer match for a total 401(k) contribution of $56,000. You can then contribute up to the lesser of $56,000 or 25% of net earnings from your small business. A business owner can also choose to open a solo 401(k) and a SEP IRA simultaneously, but total contributions and deferrals are limited to the lesser of $56,000 or 25% of net self-employment earnings.
Solo 401(K) – If you’re a business owner with no employees, i.e. a single-member LLC or sole-proprietorship, you can contribute up to $56,000 to a solo 401(k). As an employee of the business, you can make a salary deferral up to $19,000. As the owner, you can also contribute up to 25% of net self-employment income, which is net profit less half of your self-employment tax and the salary deferral made for yourself. Just like a standard 401(k) offered by employers, the solo 401(k) is comprised of pre-tax contributions & deferrals. The account is subject to tax upon withdraw and Required Minimum Distributions (RMDs) after age 70 and a half. Although a solo 401(k) excludes employers who have any employees, there is one exception: you may hire your spouse as an employee and then make contributions on their behalf.
If you operate a single member LLC or sole-proprietorship and are also employed by a separate company, you are still eligible for a solo 401(k). Salary deferrals are considered by individual taxpayer, not company basis, meaning that a taxpayer may only elect to defer up to $19,000 from their earnings before employer contributions are added. This gives sole proprietors the option to contribute to their solo 401(k) and their work-sponsored 401(k) in any proportion up to a total of $19,000, while still being able to contribute 25% of their net self-employment income from their business and receive employer contributions.
Traditional or Roth IRA – An IRA is retirement account individually established by a taxpayer and has no employer contribution portion. For 2019, individuals can contribute up to $6,000, plus an additional $1,000 contribution if over age 50. Traditional IRA contributions are tax deductible in the current year whereas Roth IRA contributions aren’t deductible, but they grow tax-free into retirement and aren’t taxed upon withdraw. Additionally, contributions are subject to income limits. A married couple filing jointly, where the taxpayer is covered by a separate retirement plan at work, is entitled to deduct their entire Traditional Ira contributions if their modified Adjusted Gross Income (MAGI) is $103,000 or less; however, the deduction begins to phase out as MAGI approaches $123,000. For Roth IRAs, a married couple filing jointly are each allowed to contribute up to $6,000 (or, $7,000 is over age 50). IRAs are fairly straightforward and simple although they don’t allow for large contributions.