The end of the year is approaching fast and many small business owners and real estate investors are looking for end of year tax savings! One of the typical year-end tax strategies is to make a tax deductible retirement account contribution. If you’re self-employed with no other full-time employees, you have some choices, but typically a SEP IRA or a solo 401k are the most popular options. With that said, the 401k strategy is by far the best in the long-run.
A SEP IRA is a traditional IRA and follows the same investment, distribution, and rollover rules as traditional IRA’s. However, a solo 401k can have both a traditional and a Roth account but your business cannot have full-time employees other than you and certain family members.
Both SEP IRA’s and 401k’s can be good for the small business owner, but it depends on your situation. Both are easy to setup and operate with low administrative costs. However, in terms of the amount of business income that is required to max out an annual contribution, a solo 401k typically provides much greater tax efficiency with contribution amounts than the SEP IRA. Also, options such as Roth and the 401k loan are available with a Solo 401k, but not a SEP IRA.
To help our clients make this move to the 401k, every year in the month of November we provide a consultation with a lawyer and complete set-up of a 401k (that YOU can self-direct) and do it all at a significant discount.
Check out a video and more information about our 2016 Special HERE.
Here are five of the most common reasons to setup a solo 401k:
- You need to make a year-end tax deductible contribution. If you need a tax deduction for the current tax year then you need to setup your solo 401k before the end of the year. Don’t wait until the last month of the year to set it up. Get it set up now so you’re not stressing during the final month to set it up. Also, make the contribution as soon as possible. Talk to your accountant because by November you and your accountant should have a pretty good idea where you’re at in terms of annual business income. If you need to wait until after the New Year to actually make the contribution that is allowed because you may need to see how your other deductions are affecting your taxable income before you can determine the appropriate contribution amount. However, keep in mind that if your business is an s-corp and you get a W2, you’ll need to know your contribution amount by the end of January which is when W2’s are required to be filed. Also, if you miss the December 31 deadline to setup a solo 401k, you can setup a SEP IRA up until the date of your business tax return deadline, including extensions and still make a contribution for 2016. Follow this link for more information on account setup and contribution deadlines.
- You want to rollover existing retirement funds and make self-directed investments into real estate, etc. This reason doesn’t involve making a tax deductible contribution for tax year 2016 and so there isn’t as much pressure to get the 401k setup before the end of the year but you may still want to set it up before the end of year deadline so you have the option to make a tax deductible contribution for 2016.
- You want to rollover existing retirement funds and take out a 401k loan. We can help you be strategic with the 401k loan and make sure you stay compliant with the IRS to pay it back in accordance with their requirements. This reason doesn’t involve making a tax deductible contribution for tax year 2016 and so there isn’t as much pressure to get the 401k setup before the end of the year but you may still want to set it up before the end of year deadline so you have the option to make a tax deductible contribution for 2016.
- You want to grow your retirement through generous contribution limits. The solo 401k (and all 401k’s) offers some of the most generous contribution limits of any retirement account. The amount of your business income will be the true contribution limit but the solo 401k allows contribution limits of up to $53,000 for 2016 ($59,000 if you’re age 50+) whereas the IRA allows contribution limits of up to $5,500 for 2016 ($6,500 if you’re age 50+). The SEP IRA is capped at $53,000 (no catch up contributions and no employee contributions are allowed). Follow this link for more information on contribution limits.
- You want to make Roth contributions. If you’re a married couple filing jointly and your modified adjusted gross income is greater than $194,000, you cannot contribute to a Roth IRA. A Roth 401k has no such income limitations. A Roth 401k is a great way to grow a Roth account through contributions but remember Roth contributions are not tax deductible.
The end of the year will be here soon, so don’t delay! I invite you to contact our office to discuss the timing of what type of account to setup, when to set it up, and how and when to make your contributions.