May 23, 2016
Retirement plans are a great option if you are looking for ways to possibly defer your current tax liability. There are a variety of retirement plans to choose from that will best cater to your specific tax situation. Below are common types of retirement plans you can benefit from by minimizing your current tax liability and maximizing future retirement savings.
You may benefit from one of the following retirement plans if you are self-employed:
Simplified Employee Pension (SEP)
SEPs are the most hassle-free deferred savings option if you are self-employed. SEPs lack the startup and operating costs of conventional retirement plans and, assuming certain guidelines are followed, can be a viable option even if you have employees. If you do have employees, you may be required to make contributions on behalf of your employees. If you receive wages and participate in a 401(k) plan with your employer but also have earnings from self-employment, you may still contribute to an SEP. The maximum amount that can be contributed for tax year 2016 is 25% of your net earnings with a cap of $53,000. The contribution can be made up to the date your tax return is due, including extensions.
For the purposes of the Solo 401(k), consider yourself both the employee and employer. As the employee, you can make elective deferrals up to 100% of your compensation with a maximum contribution of $18,000 for 2016. As the employer, you can contribute up to 25% of your compensation. The combination of the employee and employer contributions cannot exceed $53,000 annually, and must be completed by December 31st of the tax year.
Solo 401(k)s, unlike SEPs, usually have setup fees and annual administration fees, among others. Another factor to consider is that once a certain dollar amount is reached in the fund, the federal government requires an annual report to be filed each year. In addition, if you hire employees, you will no longer be permitted to have a Solo 401(k); instead you must have a regular 401(k) plan and must follow the complex federal laws in administering the plan. Despite these disadvantages, and unlike the SEP, an advantage of a Solo 401(k) is that it permits you to take loans out against your fund in certain instances.
If you are an employee, you may consider making a contribution to an Individual Retirement Account (IRA):
The Traditional IRA is useful investing tool for retirement savings. You may contribute 100% of your compensation income up to a maximum of $5,500 by the due date of your tax return, not including extensions. Depending on your annual income and whether you are already covered by a retirement plan via your employer, contributions to the Traditional IRAs may be tax deductible. This means that your contributions may reduce your tax liability. Traditional IRAs may also be rolled over to Roth IRAs, which are advantageous if you are expecting low income in any given year
A Roth IRA differs from a Traditional IRA in that current post-tax dollars are used and grow tax-free. These are not tax deductible at the time of the contribution, and contributions must also been made by the time your tax return is due, not including extensions. The maximum contribution is $5,500, but may be further limited by your income and filing status. Roth IRA contributions are generally disallowed for single taxpayers with incomes over $133,000 or married taxpayers with joint incomes over $194,000.
Non-working spouses or spouses who earn little income and are not covered by retirement plans in any part of the year are also allowed to contribute to Traditional or Roth IRAs, up to a maximum of $5,500. The deductibility of the contribution may be limited by the total amount of income earned for the year. The contribution must be made up to the date your tax return is due, not including extensions.
With each type of retirement plan stated above, there are additional contributions allowed once you reach the age of 50 at the end of the calendar year.
Required Minimum Distributions (RMDs)
It is important to bear in mind that most retirement plans require you to withdraw a portion of your savings upon reaching the age of 70 ½ years. Penalties will be incurred if the proper amount of distributions are not made
The table below compares and contrasts the retirement plans detailed in this article.
There are a number of other retirement plans available for more complex situations, such as defined benefit plans and profit sharing plans. We are happy to discuss these alternatives with you to find the best match for your particular circumstances. Please do not hesitate to contact us for advising regarding your retirement planning needs and the tax consequences associated therewith.
|Maximum Contribution||Catch-Up Contribution||Required Minimum Distribution||Last Date to Contribute|
|Solo 401(k)||$18,000 plus 25% of employee compensation, maximum at $53,000||$6,000||By April 1st of the year you turn 70 ½ and by December 31 every year thereafter||December 31st of the applicable tax year|
|Roth IRA||$5,500||$1,000||Not required||Date that you file your tax return
(not including extensions)
|Traditional IRA||$5,500||$1,000||By April 1st of the year you turn 70 ½ and by December 31 every year thereafter||Date that you file your tax return
(not including extensions)
|Spousal IRA||$5,500||0||By April 1st of the year you turn 70 ½ and by December 31 every year thereafter||Date that you file your tax return
(not including extensions)
|SEP||25% of compensation up to $53,000||0||By April 1st of the year you turn 70 ½ and by December 31 every year thereafter||Date that you file your tax return (including extensions)|