- Posted by Admin
- On May 16, 2016
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If you are self-employed or an independent contractor, you are probably pretty busy! Read on to figure out how you can begin saving for your retirement. You have several options for tax advantaged retirement saving. Speaking with a financial advisor is a great way to get help with the whole picture: your retirement, cash flow for both you and the business, and other business needs such as insurance, tax and succession planning.
Individual 401(k) or Solo 401(k) (same thing, different names!)
The individual 401(k) works like any other Traditional (non-Roth) 401(k) in that you put in pre-tax money and pay the tax on the withdrawals in your retirement.
You are both the employee and the employer. As an employee, you can contribute up to $18K to this year’s cap, plus a catch up of $6K if you are over age 50.
As the employer, you can contribute up to 20% of your compensation to the plan. Compensation is your earned income minus both half your self-employment tax and your employee contribution to the plan. You may use a vesting schedule for the employer contribution.
Note: the sum of the contributions may not exceed $53K.
Example: You pay yourself $100K in self-employment (SE) income. You subtract $7k from your half of self-employment tax. You make your contribution of $18K as an employee to your Solo 401(k). Your compensation after subtracting these is $75K. You as the employer can contribute 20% of the $75K, or $15K. This year’s total Solo 401(k) contribution is $33K.
Other advantages include:
- the ability to take loans against your savings of $50K or half the balance, whichever is less.
- being able to skip years if your cash flow is tight.
- depending on your salary, have your employee portion go in after-tax to a Roth Individual 401(k) and your employer portion into a Traditional account.
SEP-IRA (Simplified Employee Pension IRA)
The SEP-IRA works like a traditional IRA, where contributions go in pre-tax and withdrawals are taxed. The maximum your employer can do is 25% of your net (after tax) income or $53K, whichever is less. You must have worked for the company 3 of the past 5 years. You may only make employer contributions to this account.
It is not generally advantageous to use both the IRA and the 401(k), since the maximum combined amount you can have each year is $53K ($59K if you are over 50 and using catch-up contributions) for 2016. You can reach this maximum more easily with a Solo 401(k) and thus, if your focus is to contribute the max, Solo 401(k) is the better option. However, SEP-IRA’s tend to come with a lot more flexibility, can be cheaper, and have an extended time frame come tax time to make your contribution. Employer contributions are tax deductible and are immediately vested.
The Savings Incentive Match Plan is easy to set up and administer. Companies with under 100 employees may use the SIMPLE, and employer contributions are tax deductible.
Employees are eligible to participate if they received at least $5K in compensation during any two preceding years and who are expected to receive such compensation this year. Employees can contribute 100% of compensation, up to $12,500 and for those over 50, up to $15,500. Employer contributions to the SIMPLE IRA are mandatory but capped at 3% of the employee’s compensation, and also can’t be more than the employee contribution amount. Employer contributions are immediately vested.
Putting it all together
What if you are both a W-2 employee and have your own consulting business on the side? You can contribute to your employer 401(k) and set up your own SEP-IRA, for example. The annual cap on employee 401(k) contributions is $18K across all plans. However, any plans that are by unrelated employers can have their own $53K limit.
Example: You work for ABC Company and you own DEF Consulting. At ABC, you contribute $18K, the employee max, and your boss gives another $12K to your 401(k) plan there. You have a SEP-IRA at DEF, and your salary is $300K. You as the DEF employer can put the lesser of 25% of salary ($75k in this case) or $53K into your SEP-IRA, so you contribute to the cap of $53K. Your total retirement additions this year are $83K.
Don’t forget; the current cap for your retirement savings is $53K PER EMPLOYER, or $59K if you are over 50 years of age. The cap for employee salary contributions, across all plans, is $18K.
Please bear in mind that it is always best to speak with a CPA regarding tax law as it relates to your specific situation.
|SEP-IRA||Self-Employed 401(k)||SIMPLE IRA|
|2016 Employee contribution limits||Not applicable, contributions made by employer||Up to $18,000 in salary deferrals; $24,000 if age 50 or older||Up to $12,500 in salary deferrals; $15,500 if age 50 or older|
|2016 Employer contribution limits||Up to 25% of compensation; up to a maximum of $53,000||Employers may contribute up to 25% of compensation up to a maximum of $53,000. Total employer/employee contributions cannot exceed $53,000.||Either match employee contributions up to 3% of compensation; can be reduced to 1% in any two out of five years or contribute 2% of each employee’s compensation, up to $5,000|
|Key Deadlines||Establish by employer’s tax filing deadline, plus extensions, usually April 15.||Establish by Dec 31 (or fiscal year-end)||Establish by Oct 1.|
Looking for more guidance in your retirement planning? Dragon Financial Group is happy to help. Contact us or schedule an appointment here.
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