There are several retirement plans out there in the market, and each one is more complicated than the other. Selecting the best plan for yourself is no easy task and often leads to frustration. If you are a small business with employees please click here to read about pension plans to specific plans for your situation.

If you are self employed, please read below:

The single most important factor that goes in to deciding the ideal retirement plan is the amount of money you want to contribute.

If you are looking to contribute more than $60,000 each year, a defined benefit plan is inarguably the best option for you. Please refer to the defined benefit plan section below.

If you expect to contribute more than $24,000 up to $60,000, a profit sharing plan could be the best option for you assuming you are above the age of 50. Please refer to the profit sharing plan section below.

If you are starting off on saving for retirement and are looking to contribute less than $24,000 or are less than 50 years old, a solo 401(k) plan might be ideal for you. Please refer to the 401(k) plan section below.

 

 

Defined Benefit plan

Defined Benefit plans can prove to be the best pension plan if you are a self employed individual or small business owner with a lot of free cash flow and over the age of 50. It can also significantly reduce your income tax liability each year and increase your retirement savings manifold.

Let’s explore some of these benefits in detail:

Contribution Amounts: The contribution amount to a defined benefit plan has to be calculated by an actuary each year. This amount is based on your age, compensation history and the years of service. You can use our online defined benefit calculator on the right to estimate your contribution amount.

Tax Deductions: Contributions to a defined benefit plan are considered a business expense and you can avail a deduction on it. This typically means lowering your taxable income significantly each year.

Case Study: Retirement Plan for self employed individual

Client 1

Employment status: Self employed

Three year average income: 100,000 as W-2 compensation/Schedule C income/K-1 Income

Participant’s age: 50

A participant with the above mentioned parameters can accumulate $1,248,535.08 till s/he reaches an assumed retirement age of 62. In the first year, a maximum contribution of $82,788.00 can be made to the defined benefit plan.

Client 2

Employment status: Self employed

Three year average income: More than $265,000 as W-2 compensation/Schedule C income/K-1 Income

Participant’s age: 50

A participant with the above mentioned parameters can accumulate $2,621,923.68 till s/he reaches an assumed retirement age of 62. In the first year, a maximum contribution of $166,267.00 can be made to the plan.

If you need a tailored estimate, please email us at info@pensiondeductions.com

How to set up a defined benefit plan for self employed?

Setting up a defined benefit plan requires a certain amount of ground work that needs to be put in before you can actually start contributing to the plan.

At first a calculation needs to be performed about how much you can actually contribute to a defined benefit plan. Unlike 401(k) and profit sharing plans, contributions to a defined benefit plan vary from person to person. They are typically based on the age of the individual and the compensation history. You can calculate an estimate using our online defined benefit calculator on this page. A final calculation needs to be performed by an actuary though.

Once you have a final estimate from the contributions, you will need to collaborate with your CPA to ensure that you have sufficient cash flow to contribute to the defined benefit plan. Once the amount has been decided between you and your CPA, the actuary will need to draft the plan document for you.

For examples, your actuary may calculate that you can contribute $200,000 in the defined benefit plan in the first year. However, you might want a lower contribution amount and your actuary needs to be informed of that. Once you, the actuary and your CPA agree on a contribution amount, you are all set to go ahead with the next steps.

Every defined benefit plan requires a plan document which will list all assumptions of the pension plan and ensure compliance with all IRS rules and regulations. This document has to be drafted by an actuary before you can set up the investment accounts for the plan. A new TIN also needs to be registered for the pension plan as it is a distinct legal entity. The actuary will customize a plan document based on the contributions you need. Make sure your actuary provides you a plan document that is pre-approved by the IRS so you don’t need to go through the hassle yourself. You can read more about a pension plan document here.

After the plan document has been drafted, you are all set to open the investment account for the plan. You should reach out to your financial advisor or a broker to set up the accounts. Make sure you tell them to open a ‘qualified account’ so that the investment gains are not taxed at source.

You can start making contributions to the plan as and when free cash flow is available once the investment accounts are open. For the first year, the contribution will be what was decided between you and the actuary. The actuary will calculate a range for each subsequent year along with a recommended contribution amount. You are required to contribute within the range to avoid over funding or under funding the plan. The deposits can be made until you file the tax returns for your business.

All qualified plans are required to file annual returns with the IRS. Note that these returns are different from the company tax returns and your personal tax returns. Also note that the CPA or financial advisor cannot file these returns since these are required to be certified by an actuary.

The actuary will prepare a form called the Form 5500SF and certify another form called the Schedule SB. You will need to sign the form as the plan sponsor and the actuary will file it electronically. The penalties for not filing these forms run in to hundreds of dollars and the pension plan could end up getting disqualified.

If you are a self employed individual and interested in exploring the idea of a defined benefit plan for yourself please email us at info@pensiondeductions.com. We specialize in this area and can provide you with valuable advice and services that could end up saving thousands of dollars and giving a boost to your retirement planning.

DB Calculator

Please fill in the form below

Profit Sharing Plans

A profit sharing plan is a good plan for a self employed person or a business with medium or inconsistent cash flow. It allows you to contribute up to $54,000 annually or 25% of eligible compensation, whichever is lower. This type of retirement plan also provides flexibility in choosing the amount of contributions in any given year. This plan can be beneficial if the company employs the spouse as well and contributions can be made for the spouse, thereby increasing the total amount of contributions.

Are contributions made to profit sharing plans tax deductible?

Yes, the contributions to a retirement plan are tax deductible.

Are contribution amounts discretionary?
Yes, you can decide the exact amount that you want to contribute each year as long as it is lower than the IRS limits.

What is the maximum contribution limit to the profit sharing plan?

The maximum contribution is the lower of 25% of total compensation or $54,000.

If your business is incorporated as a sole-prop, it is difficult to determine the ‘compensation’ as defined by the IRS. A pension consultant has to determine it for you using advanced software as it is a circular calculation. Please email us at info@pensiondeductions.com and we shall be happy to do it for you.

If your business is incorporated as an S-Corp, the total compensation that can be considered for this calculation is only the W-2 compensation. You cannot include pass through income in these calculations, as the IRS does not consider it ‘compensation’ for pension purposes.

In the case of an S-Corp, the maximum profit sharing contribution is calculated as below:

Lower of $54,000 or 25% of W-2 compensation.

If you do issue a W-2 and need a contribution amount higher than the above calculation, a defined benefit plan may be able to give you what you want. Please use our defined benefit calculator above or email us at info@pensiondeductions.com

 

How to set up a profit sharing plan for self employed?

Every profit sharing plan requires a plan document which will list all assumptions of the pension plan and ensure compliance with all IRS rules and regulations. This document has to be drafted by a pension administrator before you can set up the investment accounts for the plan. A new TIN also needs to be registered for the pension plan as it is a distinct legal entity. The administrator will customize a plan document based on the contributions you need. Make sure the plan document is pre-approved by the IRS so you don’t need to go through the hassle yourself. You can read more about a pension plan document here.

After the plan document has been drafted, you are all set to open the investment account for the plan. You should reach out to your financial advisor or a broker to set up the accounts. Make sure you tell them to open a ‘qualified account’ so that the investment gains are not taxed at source.

You can start making contributions to the plan as and when free cash flow is available once the investment accounts are open. The deposits can be made until you file the tax returns for your business.

All qualified plans are required to file annual returns with the IRS. Note that these returns are different from the company tax returns and your personal tax returns. Also note that the CPA or financial advisor cannot file these returns.

Your pension administrator will prepare a form called the Form 5500SF which needs to be signed by you after which your administrator will file it electronically. The penalties for not filing these forms run in to hundreds of dollars and the pension plan could end up getting disqualified.

If you are a self employed individual and interested in exploring the idea of a profit sharing plan for yourself feel free to email us at info@pensiondeductions.com as we can assist you with this. We specialize in this area and can provide you with valuable advice and services that could end up saving thousands of dollars and giving a boost to your retirement planning.

 

Solo/individual 401(k) plan

People below 50 can make contributions of up to $18,000 and those above the age of 50 can make additional $6,000 contribution adding to a total of $24,000. These limits are adjusted annually by the IRS based on the cost of living increases.

 We can assist you with setting up a 401(k) plan for you. Please email us at info@pensiondeductions.com for assistance.