The 2017 tax season is mostly in the books (if you filed an extension, you have until October 15th, 2018 to complete your return), but if you became your own boss last year or this year, it might be wise to set-up a retirement account for your business and make pre-tax contributions that can grow tax-deferred. There are several relatively easy-to-create plans to help self-employed small-business owners before taxes are filed.
Here are the top three options:
This is often a good option for a one-person business. A Simplified Employee Pension, or SEP IRA, is a relatively straightforward means to put away before-tax savings. As much as 25% of your net self-employment income can be contributed, up to a maximum of $54,000 in 2017 and $55,000 for 2018.
Advantage: Discretion is the strength of this plan. Funding the account is not necessary until you file your return. If your net income turns out to be higher than expected, you can make a larger contribution and reduce your tax liability. And if you have a challenging year, you can reduce your contribution.
The Hitch: If you already have or foresee needing employees, this plan may become costly. You may be required to make contributions for all workers who are considered “covered.”
Important Dates: You have until the due date for your tax returns (April 15, 2019 for 2018 taxes), including any extensions (meaning as late at October 15, 2018 for 2017 taxes and the same date for 2018 taxes), to both create and fund a plan.
2. Individual 401(k) or i401(k)
If you have the will and means to contribute a significant portion of your earnings, then this may be an option for you. Since you are considered both an employee and the employer of your business, you can contribute two ways. As an employee, you can contribute as much as $18,500. As the employer, you can put-in another 25% of compensation, up to a limit of $55,000 for 2018, including your employee contribution. If you’re 50 or older, a catch-up contribution of $6,000 can be added as well. All-in, a quinquagenarian (a fancy way of saying someone age 50 or older) can put-away as much as $61,000 for 2018.
Advantage: Sizable, flexible contribution limits. So feel free to max-out in good years or do nil in down years.
Bonus Benefit: The possibility of taking a loan against an Individual 401(k). In certain situations, this may make sense. The borrowing limit may be up to half the account’s balance—up to $50,000—and you typically have several years to pay it back (depending on the plan sponsor).
The Hitch: If you have employees or foresee needing employees, this plan is not for you. Only self-employed business owners and their spouses can participate.
Another Catch: If you breach $250,000 in assets, you must file an annual Form 5500 report. So you may have some paperwork and associated cost if you get to this limit.
Important Dates: The deadline to open a new plan is typically December 31 (or fiscal year end) and must be funded by your tax return due date, plus extension.
3. A SIMPLE IRA
Stands for Savings Incentive Match Plan for Employees. As the acronym suggests, it was developed to be a simple retirement plan for small businesses and self-employed individuals. If you have a few employees who make between $5,000 and $100,000, and you’re looking for a plan to get retirement savings started, you’re golden with this plan.
For 2018, you can make an employee contribution of up to $12,500 pretax. Add another $3,000 if you’re 50 or older. Unlike the plans noted above, there isn’t any percentage of income restrictions.
Advantage: The paper work is (as you might have guessed) simple. We’re talking around 20 minutes to complete.
The Hitch: It might be a bit of an albatross if your business isn’t in growth mode. You’re generally required to contribute to match each employee’s salary reduction contribution up to a certain percentage no matter what the employee contributes to the account.
Another Catch: If you need to make a withdrawal from a SIMPLE IRA plan within two years of its inception, there is a relatively hefty penalty of 25%; the penalty is only a 10% fee in the other plans.
Important Dates: You can set up a plan for 2018, now. You must set one up by October 1 to make contributions for that year, and all employee contributions must be made by December 31.
So there you have it—three ways to ensure that as your own boss, your hard-earned money works harder and smarter for you.
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