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IRA Insights
For example, most individuals that are self-employed or own small businesses believe that the easiest and least expensive type of retirement plan is a SEP (Simplified Employee Pension Plan).
Although in some cases this may be their best option, it really depends on the circumstances of each individual.
Let us assume an individual has a Sub-S Corporation and earned income of $50,000 for a year and wants to maximize their tax-deductible contribution to their retirement plan. The maximum contribution to a SEP IRA is $12,500 while a Profit Sharing Plan with a 401k provision (PS/4k) would allow the individual to contribute $15,000 as an employee deferral and $12,500 as an employer profit sharing contribution for a total of $27,500.
If we changed the earned income in our assumption to $100,000, the SEP contribution would be $25,000 while a PS/4k Plan would allow an individual to contribute $15,000 as an employee deferral and $25,000 as an employer profit sharing contribution for a total of $40,000.
In each case, the PS/4k Plan provides a contribution amount of $15,000 higher.
If the self-employed individual was age 50 or older at anytime during the year, an additional $5,000 could be contributed by the employee as a catch-up deferral contribution to the PS/4k Plan. The tax savings of approximately $5,000 - $7,000 on the extra $20,000 deductible contribution will more than offset the additional administrative costs of approximately $1,500 the first year and $800 thereafter of the PS/4k Plan.
The next illustration demonstrates the value of knowledgeable advice regarding retirement plan alternatives for self employed individuals.
If you are the owner of a small business, the choice of retirement plans for your business becomes more complex when adding employees into the equation. It requires even more expertise to properly evaluate and design a plan to meet your objectives.
| | ||||||
Age | Earned Income | SEP | 401(k) Deferral | Profit Sharing | Total PS/4k Plan Contribution | Difference |
Under 50 | $50,000 | $12,500 | $15,000 | $12,500 | $27,500 | $15,000 |
50 & over | $50,000 | $12,500 | $20,000 | $12,500 | $32,000 | $20,000 |
Under 50 | $100,000 | $25,000 | $15,000 | $25,000 | $40,000 | $15,000 |
50 & over | $100,000 | $25,000 | $20,000 | $25,000 | $45,000 | $20,000 |
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