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.
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.
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.
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:
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 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.
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.
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.