The Texas Society of CPAs has issued some tips for self-employed business owners for funding their retirements.
Even for business owners who are close to retirement and have a good idea of their company’s value, changing economic conditions, new competition in the market, and a host of other unknown factors can make it difficult to be sure what the business will be worth when it’s time to retire, the TSCPA noted. They advise self-employed business owners to set up a retirement account that will provide a reliable nest egg.
Sorting Out SEP IRAs and SIMPLE IRAs
Many people are aware of two long-standing options for the self employed: SEP IRAs and SIMPLE IRAs. The Simplified Employee Pension (SEP) IRA is available to sole proprietors, partnerships and corporations.
If self-employed, a contribution can be made up to 20 percent of the net business profit each year, to a maximum of $49,000. If incorporated, a contribution can be made less than 25 percent of the compensation, or $49,000. SEP IRAs can be opened through a bank or other financial institution and are relatively easy to establish.
In a Savings Incentive Match Plan for Employees (SIMPLE) IRA, you can set aside up to $11,500 of self-employment earnings (plus another $2,500 if 50 or older). SIMPLE IRAs are generally good options for small businesses with employees that want to avoid the often high costs of setting up and maintaining a traditional company retirement plan. The employer is required to chip in either a contribution that matches up to 3 percent of employee compensation or a 2 percent contribution for each employee.
A Third Choice: Solo 401(k)s
There is another option, known as the solo or individual 401(k), open to business owners with no employees. As an employee of the business, a contribution up to 100 percent of earned income is allowed, up to the annual contribution limit of $16,500, or $22,000 if 50 or over, as long as those amounts don’t exceed 100 percent of the salary.
As their own “employers,” the self-employed can also contribute up to 20 percent of the net business profit, to a maximum of $49,000 or $54,500 if age 50 or over.
Tax Advantages Now or Later?
Because there are several options, the self employed can choose the type of tax advantages that work best. With a SEP or SIMPLE IRA or what we’ll call the traditional model of the solo 401(k), the initial contributions are deducted from pretax income. Taxes don’t have to be paid on that income now, but on withdrawals in retirement.
With a Roth solo 401(k), current contributions are not deducted from pretax income, but withdrawals from the account upon retirement may be tax free. With all these choices, the investment earnings on contributions are tax free until retirement.
Turn to a Local CPA
A CPA can offer advice on a wide range of business questions, including which retirement plan option is best. Be sure to consult a local CPA for valuable suggestions to address all financial concerns. And to get a sense of the many ways in which CPAs can help small businesses, visit the American Institute of CPAs' 360 Degrees of Financial Literacy site dedicated to small business needs.
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