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Plans for Business Owners and the Self-Employed

Plans for Business Owners and the Self-Employed

If most of your money is tied up in your business, retirement can be a challenge. So if you haven’t already set up a tax-advantaged retirement plan, consider setting one up this year. If you might be subject to the NIIT*, this may be particularly beneficial because retirement plan contributions can reduce your MAGI and thus help you reduce or avoid this 3.8% tax. Keep in mind that, if you have employees, they generally must be allowed to participate in the plan, provided they work enough hours and meet other qualification requirements. Here are a few options that may allow you to make large contributions:

Profit-sharing plan

This is a defined contribution plan that allows discretionary employer contributions and flexibility in plan design. You can make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions — provided your plan existed on Dec. 31, 2018.

SEP

A Simplified Employee Pension is a defined contribution plan that provides benefits similar to those of a profit-sharing plan. But you can establish a SEP in 2019 and still make deductible 2018 contributions as late as the due date of your 2018 income tax return, including extensions. Another benefit is that a SEP is easier to administer than a profit-sharing plan.

Profit-sharing plan vs. SEP: How much can you contribute?

Profit-sharing plan

SEP

Maximum contribution:
For 2018, $55,000 or $61,000.

Maximum contribution:
For 2018, $55,000.

Eligibility: You can’t contribute more than 25% of your compensation generally, but you can contribute 100% up to the 401(k) limits if the plan includes a 401(k) arrangement. To qualify for the higher limits, your plan must include a 401(k) arrangement and you must be eligible to make catch-up contributions (that is, be age 50 or older).

Eligibility: You can’t contribute more than 25% of your eligible compensation (net of the deduction for the contribution if you’re self-employed). So to make the maximum contribution, your eligible compensation must be at least $275,000 for 2018.

Note: Other factors may further limit your maximum contribution.

Defined benefit plan

This plan sets a future pension benefit and then actuarially calculates the contributions needed to attain that benefit. The maximum annual benefit generally is $220,000 for 2018 — or 100% of average earned income for the highest three consecutive years, if less. Because it’s actuarially driven, the contribution needed to attain the projected future annual benefit may exceed the maximum contributions allowed by other plans, depending on your age and the desired benefit.

 

*The net investment income tax (NIIT)

Taxpayers with modified adjusted gross income (MAGI) over $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately) are subject to this extra 3.8% tax on the lesser of their net investment income or the amount by which their MAGI exceeds the applicable threshold. Net investment income can include capital gains, dividends, interest and other investment-related income (but not self-rental income from an active trade or business). Beware that the NIIT kicks in at significantly lower levels of income than the top ordinary-income and long-term capital gains rates. The rules are somewhat complex, so consult your tax advisor for more information.

Many of the strategies that can help save or defer income tax on investments can also help avoid or defer NIIT liability, such as using unrealized losses to absorb gains. And because the threshold for the NIIT is based on MAGI, strategies that reduce MAGI — such as making retirement plan contributions — could also help avoid or reduce NIIT liability.

 © 2018

All information herein has been prepared solely for informational purposes only and opinions are subject to change. Past performance is not indicative of future results and all investments involve the risk of loss of principle. For information on how these general principles apply to your situation, consult an investment professional.

Article Topic Expert: Keith Kuzera

Keith is a Wealth Manager with SVA Plumb Wealth, LLC.

With more than nine years in the financial industry, Keith provides comprehensive financial planning to his clients as well as asset management, investment analysis and social security planning. He conducts educational meetings for plan participants in qualified retirement plans.

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