How Retirement Plans for Small Business can Offer Tax Savings of $308k
I know it sounds crazy, but it actually is very possible to defer $308,000 from income each and every year. At the end of this article, I’ll discuss an even better alternative. Most small business owners consider retirement plans a frivolous fringe benefit used by large companies. In truth, there is several low (or no) cost solutions for small business owners that not only make great tax sense, they diversify the owner’s investments outside of the business. Here is a brief description of retirement plans for small business.
Information for Retirement Plan Contributions for 2020 has been updated with this article.
Simplified Employee Pension Plan (SEP)
Limits: 20% of self-employed (w-2) income up to $56,000 for the owner, 25% of wages (up to $265,000) for the employee.
Employer contributions: None required. Same limit as above (i.e., employee and employer combined contributions cannot exceed $51,000).
Vesting: None. The employee is 100% vested in the money immediately.
Other: No loans available.
Cost: None other than broker account fees, which vary.
Simple IRA
Limits: $13,000 salary deferral ($16,000 if over 50).
Employer contributions: Mandatory match of 3% or 2% of all eligible employees.
Vesting: None. The employee is 100% vested in both their deferral and the employer match immediately.
Other: No loans available. 25% penalty if money is withdrawn within first two years. The employer has to have fewer than 100 employees.
Cost: None other than broker account fees, which vary.
401k
Limits: $19,000 salary deferral ($25,000 if over 50).
Employer contributions: None required. Can contribute up to 25% of total wages.
Vesting: Several options up to 6 years.
Other: Can have Roth accounts. Loans available. Can exclude employees under 21 and part-time (1,000 hours per year).
Cost: Varies. Core Wealth‘s annual plan fee is $1,250.
Solo 401k
Limits: Same as 401k.
Employer Contributions: Same as 401k.
Vesting: N/A.
Other: Can have Roth accounts. Limited to owner and spouse companies. No other employees can exist.
Cost: None other than brokerage account fees which vary.
Defined Benefit
Limits: No employee contributions.
Employer Contributions: Actuarially determined using up to 100% of wages (not to exceed $280,000),but cannot exceed $225,000.
Vesting: Several options up to 6 years.
Other: Loans available. Can exclude employees under 21 and part-time (1,000 hours per year).
Costs: Varies. Several thousand dollars.
Most businesses will be satisfied with a Simple IRA, and few use SEPs anymore. The Solo 401k is ideal for one owner or husband and wife companies with no other employees. It’s the same cost, and higher limits than a Simple IRA, and provides the ability to add a Roth-style account. For those companies looking for additional tax deferral, the traditional 401k allows more dollars to be exempted from tax. This is done with additional employer contributions. Depending on the all-important plan design, owners can retain up to 95% of the match in their own accounts. All of this is dependent on various factors, primarily wage levels and age of employees. For those companies that are producing consistent cash flow and are looking for big tax savings, consider the defined benefit plan, combined with a 401k amp up the tax savings. Because the calculations are wage and age based, the structure is ideal for companies with an older owner, and younger, lower paid employees (e.g. dentist office). It is not unusual for these plans to have contributions of several hundred thousand dollars for even smaller employers.
Employee Stock Option Plan (ESOP)
Potentially, this is the mother of all retirement plans. The options and design of ESOPs need a book, not articles, so I won’t go into detail here. I will, however, tantalize you with 100% tax-free. Sell your S-corporation to a qualified ESOP, and because the ESOP is a non-profit benefit trust (just like other retirement plans), the ESOP pays no income tax. What kind of competitive advantage would have if you didn’t pay taxes while others did? The fees are expensive, but companies that are generating north of $150,o00 in annual excess cash flow should at least look at the option. As an alternative to selling to a third party, chances are, you’ll make more after-tax money if you sell the company to you employees.
For More Information on ESOPs, Read This Article.
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