Home  |  About  |  Contact  |  Login  |  Open an Account

Sole Proprietorship Retirement Plans

There are 4 popular retirement plans for sole proprietorships.  Sole proprietors who would like to make a contribution in excess of the limits of the Traditional or Roth IRA usually select either the Individual 401k, SEP IRA, Defined Benefit Plan or Simple IRA.

What is the difference between them? Why would I choose one retirement plan versus another sole proprietor retirement plan?

Excellent question. Each retirement plan benefits a business owner differently depending on their income. For example, some plans are better suited for individuals who may not make a lot of income, but would like to maximize their retirement contribution. In some cases as much as 100% of income can be contributed into a sole proprietor retirement plan.

In a different scenario, a business owner may make a lot of income with the intent to maximize their contributions, but some sole proprietor retirement plans wouldn't be as advantageous because of their maximum contribution limits.

Another important feature to consider is would you like the flexibility of a receiving a loan. IRS rules permit loans from a Defined Benefit plan and an Individual 401k.

What are the key benefits and features of these sole proprietor retirement plans and in what situations would each be appropriate?

Individual 401k

Features: In 2014 there is $52,000 maximum contribution ($57,500 if age 50+ due to a "catch-up" provision). Loans are permitted in an Individual 401k.

Advantages: Potentially greater retirement contributions at identical income levels compared to other sole proprietor retirement plans. Loans are available through some Individual 401k providers.

Disadvantages: Potentially greater administrative responsibilities and administrative fees compared to other sole proprietor retirement plans.

In summary, who would be appropriate for an Individual 401k?

The Individual 401k and SEP IRA are the two most common retirement plans chosen by successful sole proprietor individuals. The Individual 401k and the SEP IRA have comparable maximum limits, but due to the way the contribution is calculated a sole proprietor individual may be able to contribute more into an Individual 401k versus a SEP IRA at the same income level, therefore maximizing retirement contributions and valuable tax deductions.

Here's how the calculation works. In 2014 participants in an Individual 401k can contribute up to 100% of the first $17,500 ($23,000 if age 50+) of net self employment income. In addition, a profit sharing contribution of up to 20% of net self employment income. This is important because it allows you to potentially save more than a SEP IRA at the same income level.

Also another important distinction between the SEP IRA versus the Individual 401k is an Individual 401k may allow 401k loans. Loans may be a key benefit of an Individual 401k and may be considered a valuable feature to some sole proprietors.

Is this the appropriate sole proprietor retirement plan for you?

Learn more about the Individual 401k.

SEP IRA

Features: In 2014 there is $52,000 maximum contribution.

Advantages: Easy to setup and low administrative responsibilities.

Disadvantages: An Individual 401k may provide a larger contribution and tax deduction compared to a SEP IRA. For those age 50+ there isn't an additional catch-up provision like there is with the Individual 401k. Loans are not permitted with a SEP IRA.

In summary, who would be appropriate for a SEP IRA?

The SEP IRA is a great choice for sole proprietor who would like to contribute 25% or less of compensation. Compensation is defined as W-2 wages if incorporated or self employment income as a sole proprietorship. A SEP provides high maximum contribution limits, but an Individual 401k may allow a greater contribution at the same income level. IRS rules do not permit loans from a SEP IRA.

Is this the appropriate sole proprietor retirement plan for you?

Learn more about the SEP IRA.

Defined Benefit Plan

Features: May provide the largest contribution of any sole proprietor retirement plan.

Advantages: Depending on the age and income of the business owner, annual contributions can exceed $100,000 or more. Loans may be permitted.

Disadvantages: Of the 4 sole proprietor retirement plans discussed here, this plan has the greatest administrative fees. Annual contributions are not as flexible as an Individual 401k or SEP IRA.

In summary, who would be appropriate for a Defined Benefit Plan?

The defined benefit plan is appropriate for those age 45 or older who wish to make tax deductible contributions in excess of the maximum limits of the Individual 401k or SEP IRA. Defined benefit plans have greater administrative fees and more rigid annual funding requirements, but may be ideal for sole proprietors who wish to shelter the largest percentage of their income and/or who want to make the largest retirement plan contribution permitted by IRS rules.

Is this the appropriate sole proprietor retirement plan for you?

Learn more about the Defined Benefit Plan.

Simple IRA

Features: In 2014 there is a $12,000 maximum contribution or $14,500 if age 50+. In addition there is a maximum 3% employer contribution.

Advantages: Low administrative fees and responsibilities.

Disadvantages: Low maximum contribution limits. Loans are not permitted

In summary, who would be appropriate for a Simple IRA?

Sole proprietors that have a Simple IRA are able to contribute up to 100% of their income up to the maximum contribution limits. As a result, this plan would be a good choice for someone that doesn't have a high income, but would like to contribute beyond the limits of an IRA and would like to contribute a large percentage of their income. A good candidate for this plan doesn't mind the relatively low contribution limits of a Simple IRA compared to a SEP or Individual 401k. For example, a sole proprietor with $20,000 in net income could contribute more into an Individual 401k than a Simple IRA. Sole proprietors who have a low income, but would like to contribute more than the maximum limits of the Simple IRA may want to consider an Individual 401k instead.

Is this the appropriate sole proprietor retirement plan for you?

Learn more about the Simple IRA.

 

How Can BCM Help You?

Beacon Capital Management Advisors (BCM) is experienced in setting up retirement plans for our clients. BCM provides retirement plans to the self employed, freelancers, entrepreneurs, independent contractors and small business owners and is registered in 50 States. Complete the form below and a BCM Advisor will promptly respond to your inquiry.

Name
Telephone
Email Address
How can BCM help you?
*Safety and confidentiality are very important to us. Read our privacy policy.
|

 

Disclosures:

*The information on this page is for informational purposes only and does not constitute, and should not be construed as, professional, legal or tax advice. To determine your individual tax situation and specific needs, please consult a professional tax advisor.

*Information contained in these sections merely highlight some benefits. There are risks involved with all investments that could include tax penalties and risk/loss of principal.