As a sole proprietor, setting up the right retirement plan is a valuable undertaking; not only are you saving for future financial security, but you may also receive a tax deduction on your plan contributions. There are several types of retirement accounts to choose from, but most self-employed taxpayers prefer the SEP IRA and the Solo 401(k). Key advantages of these plans over other types of retirement accounts are higher annual contribution limits, extended funding deadlines, and continued saving past age 70 ½.
Both plans allow for an employer profit sharing contribution, limited to the lesser of 1) 20% of net self-employment earnings, or 2) $54,000 for 2017 (up from $53,000 for 2016). The Solo 401(k) allows participants to make employee elective deferrals each year, as well. Employees have the option to contribute up to $18,000 of their earnings in 2017, with an additional $6,000 “catch up” contribution available to those 50 years and older. Since sole proprietors act as both the employer and the employee, those with Solo 401(k) plans established by year-end would be eligible for the additional employee deferral in 2017. It is important to note that contributions are based on net income, so if at least $270,000 is not earned in 2017 (up from $265,000 for 2016), the maximum contribution amounts listed above may not be allowed.
Self-employed taxpayers would deduct their contributions to these plans on Page One of the Form 1040, as an adjustment to arrive at adjusted gross income “AGI.” They will also have until the due date of their returns, including extensions, to fund these accounts each year. For the 2017 tax year, a sole proprietor would have until April 15th, 2018 to make a tax-deductible contribution to a SEP IRA or Solo 401(k), and as late as October 15th, 2018 with a timely filed extension.
If a taxpayer, still working after age 70 ½, has an employer-provided SEP IRA or Solo 401(k) plan, he or she may be allowed to delay taking their required minimum distributions “RMDs” from the plan until April 1 of the year after retirement. It is important to note that withdrawals from any other IRAs (with the exception of a Roth IRA), would still be required. For a taxpayer to qualify for this “still working” exception, the following rules apply:
- Taxpayer is considered employed throughout the entire year
- Taxpayer owns no more than 5% of the company
- Taxpayer participates in a plan that allows for delayed RMDs
It is possible for taxpayers to continue making contributions to their employer-sponsored 401(k) and SEP IRA accounts after age 70 ½, as well. If he or she is still working, employers must continue to make contributions to the SEP IRA of an employee who is over age 70 ½ if it makes similar contributions to younger employees’ accounts. What a great long-term savings opportunity!
Below is a side-by-side comparison of some of the primary advantages and disadvantages of each of the retirement plans, as well as a link to a chart from the IRS that also illustrates the benefits of these two plans and others.
At Maddox Thomson, our goal is to keep you well informed and help you attain your financial goals. Please call or email us at [email protected] if you would like assistance in understanding or implementing these options.
SOLO 401(K) | SEP IRA |
Advantages | Advantages |
|
|
Disadvantages | Disadvantages |
|
|