Successful self employed business owners are often looking for ways to increase their self employed tax deductions. One of the most significant tax deductions for the self employed is to make a contribution to a self employed retirement plan.
Self employed retirement plans for one person business, an owner and spouse business or a partnership (no W-2 employees)
If a small business owner is a only employee or if the only employees are the owner and spouse or if the small business is a partnership that employs only the partners and has no W-2 employees then the decision of which retirement plan to select becomes much easier. Business owners who fit this scenario frequently select either the Individual 401k, SEP IRA, Defined Benefit Plan or SIMPLE IRA. These retirement plans are popular because they offer high annual contribution limits and some plans permit loans. Below are some of the defining features of each of these self employed retirement plans.
- 2017 SEP IRA contribution limit is $54,000.
- Easy to set up and minimal administrative responsibilities.
- The Individual 401k may provide a larger contribution compared to a SEP IRA at the same income level.
- For those age 50 or older there isn't an additional catch-up provision like there is with the Individual 401k.
What are the advantages of a SEP IRA?
The SEP IRA has broad appeal due to its high maximum contribution limits and its ease to set up and maintain. The 2017 SEP IRA contribution limit maximum is $54,000. The annual contribution into a SEP IRA is based on a percentage of W-2 wages if you are incorporated or net income if you are a sole proprietorship. The SEP IRA is a great choice for self employed business owners who would like to contribute up to 25% of their W-2 wages or 20% of net self employment income.
S or C corporation or a LLC taxed as a corporation.
- For incorporated businesses up to 25% of W-2 wages can be contributed into a SEP IRA.
Sole proprietorship, partnership or a LLC taxed as a sole proprietorship
- Annual contributions up to 20% of your net adjusted self employment income (or net adjusted business profits) can be contributed into a SEP IRA
Learn more about a SEP IRA.
- 2017 Individual 401k contribution limit is $54,000 ($60,000 if age 50 or older due to a "catch-up" provision).
- 401k loans are permitted with an Individual 401k plan. Loans are permitted up to 50% of the total value of the Individual 401k up to a maximum of $50,000.
- Roth 401k - There is an option to make Roth 401k contributions with the salary deferral portion of the Individual 401k. Contributions into a Roth 401k are not tax deductible, but withdrawals are tax free after age 59 ½.
- Potentially greater administrative responsibilities and administrative fees compared to a SEP IRA.
What are the advantages of the Individual 401k?
The Individual 401k and SEP IRA are popular because both plans have high contribution limits and have completely discretionary annual funding requirements. In 2017 a SEP IRA has a maximum contribution limit of $54,000 and an Individual 401k has a contribution limit of $54,000 ($60,000 if age 50 or older).
A SEP IRA is easier to setup and has less administrative costs than an Individual 401k, however an Individual 401k may allow a greater contribution at the same income level due to the way the contribution is calculated.
After tax Roth contributions can be made into an Individual 401k. Roth 401k contributions are not tax deductible, but are received tax free when withdrawn after age 59 ½. SEP IRA contributions can only be made pre-tax and does not have a Roth option.
Another important distinction between these retirement plans is an Individual 401k has a loan provision. IRS rules do not allow loans with a SEP IRA. Individual 401k loans are permitted up to 50% of the total 401k value with a $50,000 maximum.
Learn more about the Individual 401k.
Defined Benefit Plan
- Depending on the age and income of the business owner, annual contributions can exceed $100,000 or more.
- Loans may be permitted, however this may increase annual funding requirements.
- More expensive to set up and to maintain.
- Rigid annual funding requirements.
What are the advantages of a Defined Benefit Plan?
The Defined Benefit Plan is appropriate for those age 40 or older who wish to make tax deductible contributions in excess of the maximum limits of the Individual 401k or SEP IRA. Defined Benefit Plans offer substantial tax deductible retirement contributions and significant future retirement income. Depending on your age and income the annual contribution to a Defined Benefit Plan can exceed $100,000.
Defined Benefit Plans have greater administrative fees and more rigid annual funding requirements, but may be ideal for business owners who wish to shelter the largest percentage of their income and/or who want to make the largest retirement plan contribution permitted by IRS rules.
Learn more about the Defined Benefit Plan.
- A SIMPLE IRA is easy to set up and has low administrative responsibilities.
- 2017 SIMPLE IRA contribution limit is $12,500 or $15,500 if age 50 or older. In addition there is a maximum 3% employer contribution.
- Relatively low maximum annual contribution limits.
- Loans are not permitted.
What are the advantages of a SIMPLE IRA?
Self employed business owners that have a SIMPLE IRA are able to contribute up to 100% of their income up to the 2017 contribution limit of $12,500 or $15,500 if age 50 or older. As a result, significant contributions can be made into a SIMPLE IRA even at lower income levels. A good candidate for this plan doesn't mind the relatively low maximum contribution limits. Self employed individuals who would like to contribute in excess of the limits of a SIMPLE IRA should consider an Individual 401k since it has higher contribution limits. Compare the contribution limits of the SIMPLE IRA versus Individual 401k.
Learn more about the SIMPLE IRA.