Year-End Planning Ideas for Owner-Only Businesses

Worried that all of the retirement plan opportunities for 2016 have passed? There is still time to make a difference! Owner-only businesses have until December 31 to establish 401(k), profit-sharing or defined benefit/cash balance plans. Funding may be completed next year as late as the business’ tax filing deadline, including extensions.

Saving Up to $53,000 Your client may benefit from taking advantage of features available in a 401(k) but absent in a SIMPLE or SEP IRA arrangement. The Roth 401(k) feature of a Solo(k) 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, because it allows a plan participant to defer up to $18,000 ($24,000 if age 50 or older) on an after-tax basis. By forgoing a current-year deduction on salary deferrals, you gain access to tax-free growth and distributions during retirement. Unlike a Roth IRA, a 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.

 Create More Tax-Free Income with After-Tax 2.0 If your client is interested in growing their tax-free retirement income beyond Roth 401(k) contribution, then making an after-tax contribution and converting it to Roth inside the plan may make sense. Forgoing a current year deduction (i.e., reducing or replacing profit-sharing contribution with after-tax contribution) may lead to better outcomes with tax-free growth and distributions, especially when retirement is more than 10 years away.

 Get Maximum Contribution without Maximum Pay A business owner with at least $140,000 in plan compensation can achieve the maximum contribution 401(k) profit-sharing plan. By contrast, a SEP would require at least $212,000, 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 are available in a 401(k) plan, which means someone over age 50 with a SEP IRA could never reach the contribution potential of a 401(k) profit-sharing plan.

 Saving More Than $53,000 An owner-only cash balance plan, Solo(cb) provides you with an opportunity to introduce clients to an innovative strategy. The most obvious way a solo(cb) plan benefits clients is through the plan’s high-deductible contribution limit. Contributions to an owner-only cash balance 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 cash balance plan. First, an owner-only cash balance 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.

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 cash balance plans.

A Solo(cb) Cash balance plans may help overcome limits that other plans may not be able to break through because of income pattern or deduction limits. Consider this case study: A 55-year-old consultant is on a phased-in retirement trajectory with full retirement in four years. The business owner’s W-2 compensation is $50,000; an additional $200,000 is paid as S-corporation shareholder distribution reportable on K-1. Since K-1 income is not eligible compensation for determination of retirement benefits and the W-2 wages are limited to $50,000, the maximum SEP IRA contribution is $12,500. This is where a cash balance plan comes to the rescue. Unlike defined contribution plans and IRA-based plans, cash balance plan benefits may be based on past earnings. In our discovery process, we learned that the business operated as a sole proprietorship reporting income on Schedule C. Using past compensation history, the cash balance plan delivered a contribution of $125,000. By adding a Solo(k), we were able to increase the combined plan contribution to $151,000. This allowed the client to realize a $57,900 tax benefit net of plan costs.

 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 calendar year; as long as they are contributed before the employer’s tax filing deadline, including extensions, they may be 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.