As the end of the tax year approaches, we’ve had an increase in the number of business owners inquiring about small business retirement plans. Let’s take a look at two small business retirement plans that are available for small businesses owners and why someone may want to choose one plan over the other.
Two small business owners
Let’s take a look at two small business owners: George and Brenda. Both are real estate agents, neither has employees, and both will make approximately $57,000 for 2020.
- Brenda inherited $900,000 earlier in the year, but she is in her 40s and knows she needs to keep working to maintain her cashflow. She is building her business.
- George is in his 40s, is new to the real estate business, and also wants to build his business.
Two small business retirement plans
Both are looking at small business retirement plans and would like something that is tax deductible. SEP IRA plans for 2020 enable a business owner to put approximately 20% of income away to a maximum of $57,000. Solo 401k plans for 2020 enable a business owner to put 100% of income away to a maximum of $57,000.
A SEP IRA plan would permit either of the two to put up to $11,400, (20% of $57,000), into a retirement plan and deduct it from their income.
A Solo 401k plan would permit either of the two to put up to $57,000 into a retirement plan and deduct it from their income.
Since Brenda has good liquidity, she decides to open a Solo 401k plan and put the entire $57,000 of income into her retirement plan. She shows no income for the year. She can do this because of the cash flow she has access to from the $900,000 she inherited earlier in the year. Even though that inheritance has nothing to do with the business, because she has qualifying business income, her Solo 401k plan contribution can come from any monies she has.
The only stipulation is that there must be matching income from the business. For example, if her business had only made $40,000 she could not contribute $57,000 even if she had that money. George, without the excess cash to contribute the full $57,000, decides to open a SEP IRA and put the maximum 20% away, which is $11,400.
Different business owners may have vastly different liquidity. If you are a small business owner, your savings and investment accounts may give you the opportunity to put a lot more pre-tax money into your retirement plan than you initially thought. Take a hard look at what is available to you, talk to your accountant, and give your investment advisor a call. As always, we welcome your questions!