Consider managing your risk now by investing in a tax-advantaged retirement account. Employer-sponsored retirement plans offer a number of potential benefits, including current tax deductions for the business and tax-deferred growth and/or tax-free retirement income for its employees.
Unlike “qualified” plans that must comply with specific regulations from the government, Individual Retirement Accounts (IRAs) are less complicated and typically less costly.
You can open a Traditional IRA for yourself whether or not you have employees. The Traditional IRA is not associated with your business. For 2014, contributions are allowed up 100% of Earned Income or $5,500. For those age 50 and older, contributions are allowed up to $6,500. For Married Filing Jointly tax filers, the contribution is deductible if Adjusted Gross Income is less than $96,000 and partially deductible if AGI is less than $116,000 for 2014.
A Roth IRA, just like the Traditional IRA, can be opened for yourself whether or not you have employees. For 2014, contributions are allowed up to 100% of Earned Income or $5,500 or $6,500 if age 50 or older. For Married Filing Jointly tax filers, contributions are allowed if Adjusted Gross Income is less than $181,000 and partial contributions are allowed if AGI is within $181,000 – $191,000 for 2014. Contributions to Roth IRAs are not deductible.
A SEP IRA allows you to set up an IRA for yourself and each of your eligible employees. Although you contribute the same percentage of pay for each employee, you’re not required to make contributions every year. For 2014, combined contributions, from both employer and employee, are limited to 25% of pay, up to a maximum of $52,000 for each employee (including yourself).
A SIMPLE IRA allows employees to contribute up to $12,000 in 2014 on a pretax basis. Employees age 50 and older may contribute up to an additional $2,500. As the employer, you must either match your employees’ contributions dollar for dollar up to 3% of compensation, or make a fixed contribution of 2% of compensation for every eligible employee. (The 3% contribution can be reduced to 1% in any two out of five years).
Although these types of plans have more stringent regulatory requirements, they offer more control and flexibility. (Special rules may apply to self-employed individuals.)
With a profit-sharing plan, only the business contributes. Contributions are discretionary (although must be “substantial and recurring”) and placed into separate accounts for each employee according to an established allocation formula. There’s no fixed amount requirement, and when profitability is particularly tight, you generally need not contribute at all.
A 401(k) plan allows employees to make both pre-and after-tax (Roth) contributions. Employee contributions cannot exceed $17,500 in 2014 ($23,000 for those 50 and older) or 100% of compensation whichever is less, and employers can choose to match a portion of employee contributions. These plans must pass a test to ensure they are nondiscriminatory; however, employers can avoid the testing requirements by adopting a “safe harbor” provision that requires a set matching contribution based on one of two formulas.
With a Defined benefit (DB) plan you promise to pay employees a set level of benefits during retirement, based on a formula typically expressed as a percentage of income. DB plans generally require an actuary’s expertise to put into place.
Total contributions to profit sharing and 401(k) plans to any one person cannot exceed $52,000 or 100% of compensation in 2014. With both plans (except safe harbor 401(k) plans), you can impose a vesting schedule that permits your employees to become entitled to employer contributions.
For the self-employed
Sole entrepreneurs may consider an Individual (or “solo”) 401(k) plan. These plans are very similar to a standard 401(k) plan, but because they apply only to the business owner and a spouse, the regulatory requirements are not as stringent. They can also have a profit-sharing feature, which can help you maximize your tax-advantaged savings potential. Individual 401(k) plans allow salary deferrals up to $17,500 per year or $23,000 per year for those age 50 and older.
The sole proprietor can also make a Profit Sharing contribution into the Individual 401(k) as long as total contributions for the year do not exceed $52,000 or 100% of compensation in 2014. The maximum Profit Sharing contribution is limited to 25% of pay, but if age 50 or older an additional catch-up contribution of $5,500 is allowed.