Would you like to put more money away for retirement?
Posted On: 12-19-2016 | Posted By: Jessica Lehmen, CPA
As we near the end of the year, it is a good time to start thinking towards the future and your ultimate goal…retirement! If you are ready to start saving or to increase the amount you are currently contributing, now is a great time to consider your options.
There are many tax favored account types to choose from but determining what you are eligible for can be tricky. In this article, we provide some basic information on some of the most popular retirement savings vehicles but you should always consult your tax advisor to determine what works for you.
Individual Retirement Accounts (IRAs)
IRAs are one of the most broadly applicable options because you, as an individual, can set one up and you are generally eligible to contribute as long as you have “earned income” such as wages or self-employed business income.
- Traditional. The traditional IRA contributions limits for the 2016 year are the lesser of your earned income or $5,500 or $6,500 if you are 50 or older. Contributions for 2016 can made up until April 17, 2017. The limits do change with inflation, but the 2017 limits are the same as 2016.
If you or your spouse are eligible to participate in a retirement plan with your employer, the deductibility of the contributions can be limited based on your income levels. If you are single and covered by a retirement plan at your employer, the deductibility of your contribution phases out with modified adjusted gross income between $61,000 and $71,000. If you are married and file joint, the deductibility phases out for the covered spouse between $98,000 and $118,000 and for the noncovered spouse between $184,000 and $194,000.
However, even if the contribution isn’t deductible, you can still contribute. If all of your contributions were deductible, the distributions in retirement will be fully taxable. Your nondeductible contribution will allow you to take your distributions in retirement tax free to the extent of your nondeductible contributions. We will discuss another option for handling those nondeductible contributions in future articles.
- Roth. The Roth IRA is particularly popular with young savers because your contribution isn’t deductible now, but all future earnings and distributions in retirement are tax free. The contribution amounts and deadlines are the same as a Traditional IRA; however, if you are above the income limits you cannot contribute directly to a Roth IRA. For 2016, single taxpayers lose the ability to contribute to a Roth with modified adjusted gross income between $117,000 and $132,000 or $184,000 and $194,000 for married filing joint taxpayers.
- “Back-door” Roth. While there are income limits to whether or not you can directly contribute to a Roth, there are no income limits for whether you can rollover another IRA into a Roth. If you want to get money into a Roth but you are above the income limits, one strategy is to contribute to a traditional IRA, which is probably nondeductible for you because of the income thresholds, and then to roll that money over into a Roth IRA immediately. However, if you have multiple IRA accounts, both nondeductible and deductible, this strategy could result in taxable income, so consult with your tax advisor before you do anything.
Simplified Employee Pension (SEPs)
A SEP must be set up by an employer, but that employer might be you if you are self-employed. The maximum contribution by a business to an employee’s SEP account is the lesser of $53,000 or 25% of the employee’s compensation for 2016. The nice thing about a SEP is that the employer has until the due date of the employer’s tax return to establish and fund the plan. Contributions are deductible by the employer and taxable when distributed during retirement. This plan has low administrative costs and can be particularly beneficial when you as the business owner are the only employee. If you have employees, this plan can get expensive because you must contribute the same percentage of their salary as you contribute of your own.
SIMPLE IRAs are for employers with fewer than 100 employees. The plan allows employees to make pre-tax contributions of their own money (deferrals) of up to $12,500 per year plus an additional $3,000 if they are over 50. Deferrals are limited by compensation, so if you or the employee make less than $12,500 (or $15,500 if over 50), you or the employee can only defer up to the amount of individual compensation. For C and S Corporations, the compensation of the owner is generally measured by the amount paid in wages. For partnerships and sole proprietorships, compensation of the owners is measured by the amount determined to be their self-employed income.
The employer generally then commits to one of the following contribution amounts:
- 2% of each employee’s wages, or
- matching of employee deferral up to 3% of employee’s wages.
The SIMPLE plan must be set up before October 1st of the year you want to make the plan effective so it is too late for 2016, but this could be an option for 2017.
401(k) and/or Profit Sharing
401(k) and profit sharing plans are plans that can be set up by an employer separately or in combination with each other. They offer quite a bit of flexibility in plan design but that also means there can be a lot of complexity and administration. Basically, if an employer offers a 401(k), employees will be given the option to make deferrals of up to $18,000 per year plus an additional $6,000 if over 50 (also limited to the total compensation of the individual). These deferrals can be pre-tax or, if the plan allows, the employees can elect after-tax Roth 401(k) deferrals. The employer has many options to consider for how much they want to contribute for their employees but the lesser of compensation or $53,000 (plus $6,000) limit applies for maximum contributions.
- For Employees If your employer offers a 401(k), make sure you know what the matching formula is, if any, so that you defer enough of your own money to get the maximum contribution from your employer. Also, find out if your plan offers the Roth 401(k) option. Depending on your situation, it might be wise to make Roth deferrals instead of regular pre-tax deferrals.
- For Employers If you don’t currently have a 401(k) or profit sharing plan, now might be a good time to ask if one would work for you.
If you do have a 401(k) or profit sharing plan, it is a good idea to set up a yearly plan review to make sure you are offering the features and contribution formulas that best meet your goals.
Which plan is best for you?
This is just a sampling of the most commonly used plan types, but that doesn’t mean there aren’t others that might suit your needs. Determining what works best for you and/or your business can be very complicated.
If you would like to consider saving more for retirement please contact your WK advisor at (573) 442-6171 or (573) 635-6196 to help determine the most tax effective way to do so.