There is still time to establish a plan for the current tax year and take advantage of the deduction, but the deadline is very close. Owner-only businesses have until December 31 to establish 401(k), Profit Sharing, or Defined Benefit Plans. Funding may be completed next year, by the business’ tax filing deadline, including extensions.
Savings Goal: Up to $50,000
Your client may benefit from taking advantage of features available in a 401(k) Plan but absent in a SIMPLE or SEP IRA arrangement. The Roth 401(k) feature is a good example. A 401(k) plan might be off your client’s radar because they may not need a large deduction. That’s where Roth comes into play. Roth 401(k) allows a plan participant to defer up to $17,000 ($22,500, if age 50 or older) on an after-tax basis. By foregoing a current-year deduction for salary deferrals, he or she gains access to tax-free growth and distributions during retirement. Unlike Roth IRA, Roth 401(k) is available regardless of income level, provided the plan document contains a Roth provision. Profit sharing or matching contributions made to the plan receive a traditional tax treatment: they are deductible, grow on a tax-deferred basis, and are subject to taxation as ordinary income when distributed. By receiving Roth treatment on a portion of their contributions, clients are able to diversify their tax treatment both now and in retirement.
Life Happens, Have a Loan
Loan availability is another example of a feature available in a 401(k) Profit Sharing Plan; loans are not an option in an IRA-based plan. Life happens, and many business owners periodically find it necessary to access their 401(k) savings in pre-retirement to provide cash injection or cover a temporary shortfall. Qualified plans allow participants to borrow up to one half of the value of their vested account, capped at $50,000. Loans generally can be repaid over five years. The length of the loan can be extended beyond five years in some instances; for example, when the loan is used toward purchase of primary residence. The interest the borrower pays on their loan goes back into the plan for their benefit.
In an Emergency, There’s a Way
A 401(k) / Profit Sharing plan can permit in-service distributions prematurely in the event a participant experiences a financial hardship. A premature distribution taken under these circumstances is subject to ordinary income taxes and a 10% penalty, unless an exception applies. This tax treatment is similar to tax treatment of a premature distribution from a SIMPLE, SEP, or Traditional IRA. A plan containing this provision essentially provides permanent access to assets in the plan should a financial emergency arise.
Maximum Contribution without Maximum Pay
A business owner with at least $132,000 in plan compensation can achieve the maximum contribution 401(k) Profit Sharing plan. By contract, a SEP would require at least $200,000, and a SIMPLE IRA contribution could never reach the 401(k) savings level. As a rule of thumb, a 401(k) / Profit Sharing plan always allows at least equal, and usually greater contributions than a SIMPLE or SEP IRA.
Additionally, the catch-up contributions available in a 401(k) Profit Sharing plan mean someone over age 50 with a SEP IRA could never reach the contribution potential of a 401(k) Profit Sharing plan.
Savings Goal: Greater than $50,000
An owner-only Defined Benefit plan provides you with an opportunity to introduce clients to an innovative strategy. The most obvious way a solo Defined Benefit plan benefits clients is through the plan’s high deductible contribution limit. Contributions to an owner-only Defined Benefit plan, depending on the age and income of the client, could reach $100,000 or more.
There is a misconception surrounding the funding flexibility of a Defined Benefit plan. First, an owner-only Defined Benefit plan can be combined with a Solo(k) Plan. In an owner-only plan, all contributions to the Solo(k) are discretionary, providing an opportunity to reduce funding on a year-to-year basis.
Second, those who adopt Defined Benefit plans before 12/31 can establish the plan with a minimum benefit formula. The benefit formula can be amended upward until March 15 if the client wishes to contribute more than the minimum; in essence, this planning technique allows more time to dial into the exact funding amount with a perfect hindsight. In subsequent years, the Defined Benefit plan’s contribution requirement will vary with the client’s income and the performance of plan assets. Each year, the client will be provided with a minimum required contribution, recommended contribution, and maximum deductible contribution amount. Many are unaware that this level of flexibility exists within defined benefit plans.
Who can Take Advantage of These Opportunities?
A business doesn’t necessarily need to employ only the owner to be considered an owner-only plan. A plan that covers the business owner and spouse, or partners and their spouses, is considered an owner-only plan. However, even when non-owner employees are in the picture, advanced plan design allows a great deal of flexibility in targeting specific groups of participants thus managing plan costs and efficiency.
There is Still Time
It’s not too late to take advantage of qualified plan opportunities. Employer contributions are not due until the following year; as long as they are contributed before the employer’s tax filing deadline, including extensions, they are deductible for the preceding year.
As your clients and prospects sit down to do their year-end tax planning, consider introducing these concepts to them. Reach out to CPAs with whom you have a shared client, approaching them with innovative ideas will potentially open opportunities that are not on your horizon today. And remember, you don’t need to be an expert. Retirement Services team is ready to help all the way, from presenting opportunities to prospects and their tax advisors to discovery to a sales meeting. Give us a call today, (888) 926-0600 or send us an email to firstname.lastname@example.org .