There's been a lot of talk recently about different plan options for small business, particularly from the reselling crowd, so here's a quick and dirty post on what you can, can't and should, or should not do. I'm going to broadly generalize and judge because that's the way I roll in such posts.
Types of Plan available
Retirement plans generally fit into a DC or DB bracket. Some straddle this a little.
What plan for resellers?
Firstly, you're probably going to start with a DC plan, unless you are fully loaded on that from other employment. Once the DC plan is working effectively, it is worth looking at other types of Plans. Ballpark: You're probably going to need to be over $100K before DC plan deductions to really start looking at DB/Cash Balance on the top.
What DC Plan?
SoloK, SEP IRA, Simple IRA are your real choices.
The numbers in green are Employee Contributions that come from salary deferral, lowering taxes. These don't play nicely with one another. The max Employee contribution per year (2016) is $18K. This is across all accounts. The regular, employer sponsored 401(k) at your 'real' job is a green number. This means if you are putting in $17K to your work plan, you can only put in $1K on the Employee side of your small business plan (the SoloK or the Simple IRA).
The numbers in orange are Total Annual Max. This means that in theory, if you have a great employer, you could put in $18K and they could match you $35K.. or if you are self employed you can be that great employer with either a SoloK or a SEP IRA.
You can't go over the hard limits of $18K Green (Employee) or $53K total with the Employer additions. You can't have 3 401(k) plans and put away $159K... with one exception:
For those over 50 you can add a 'catch up' your Employee side contribution. For the SoloK the catch up is $6K for the Simple IRA the catch up is $3K. The SEP isn't Employee side, it is an Employer only plan, there isn't a catch up.
More Integration (Technical Stuff)
At this point, I'm no longer talking about the Simple IRA because it is lame.
Rules for SoloK
The SEP for the Self Employed person runs off Net Profit. You can see the worksheet here. Contrast that with the SoloK that runs off Salary. This raises interesting questions, and your Net Profit, after deductions might push you one way or the other. Note that while you cannot contribute to a SEP and SoloK in the same year, you can have both plans, so you can swap later.
SoloK can absorb profit quickly. You can direct $18K into salary, defer it into Employee side, and pay no Tax (though you still owe FICA and FUTA). You can then add an Employer 25% on top.
SEPs don't eat your 'real' 401(k) Employee side limit of $18K so if you have a good job and are maxing this out, a SEP has value over a SoloK.
Example:
You earn $13K from your Reselling gig, and you are maxed out on your 401(k) at real work. If you want to fund a SoloK you only have the Employer side available so you might pay yourself around $8K Salary (with tax!) just to be able to kick in an Employer contribution of about $2K.
Instead, if you ran with a SEP, you could deduct the heck out of the $13K (legitimately) and if you could kick in a small amount of SEP contribition, and run a very small payroll, lowering Triple tax, FICA, FUTA.
However, if you didn't have a plan at work, and you had income of say, $30K, you'd be far better off with the SoloK, maxing out the $18K on the Employee side, topping up with an Employer contribution of $4.5K, and expensing the balance, if legitimate. Tax on the $30K would be negligible.
A SEP here, barring very high expenses, would only be able to deduct around $5K, and taxes would be considerably higher.
How to set up the account
SoloK
SoloK is considered 'harder' and more complex. You'd have to run payroll to operate it, which can be $15-60 per month depending on how hands on it is. Beyond this, there are a few things happening in a SoloK plan:
The Plan papers - these outline and define the plan. You can write your own rules here based on features you want, such as allowing Roll ins, Roth elections, etc.
Plan Administration: Typically done by a TPA (Third Party Administrator)
Custodian: Where you house the funds, a Brokerage account in a trust account
Many people pay money to build a plan and have a TPA report for it, however, you don't really need to worry about this until the plan reaches $250K in assets, when form 5500 reporting is required. The reason for this is that the TPA helps with the 5500 (it isn't rocket science though).
So what happens with such a system is you pay someone to write your papers, and then you retain them to report on the plan. You can pay a lot, or a little. If you go this route, I recommend talking with Ascensus they will build your plan, you find a custodian who will work with you, and they report. Ascensus charges about $365 to establish the plan and under $100 per year to report if memory serves.
However, what you can also do is adopt what is called a 'Model' plan this is a prewritten document that covers part A of things (the paperwork to establish) but does not report annually on form 5500. I think that most people who are setting up a plan can start with such a thing, and then pivot to a Ascensus/other custom plan when assets are high, and when they are, draft in roll in terms to the new plan, so you can transfer the funds over without a tax event.
Vanguard offers such a model. You could open it for no fee, and fund it until you get near the $250K level, and pivot.
A SoloK must be established by fiscal year end, 12/31 unless you are special.
SEP IRA
A SEP is a lot easier, none of the TPA issues, and can be opened by 4/15 of the following year.
Conclusion
SEP's and Solo's are great plans - but your personal circumstances (such as how much is the green bucket) will dictate which is best. Also, while deferring taxes is great, not paying them at all is better.
Once you max out these you can look at Cash Balance or other plans, and tuck away another $58-$265K on top of your SoloK. When you do, it is important to factor in AUM vs Flat Fee custodial fees.
Types of Plan available
Retirement plans generally fit into a DC or DB bracket. Some straddle this a little.
- DC Plans: Defined Contribution. This is all about how much you can tuck away each year, the Contribution amount. A DC plan is a 401(k), 403(b), IRA, and can be a Roth or Traditional
- DB Plans: Defined Benefit. This is a plan that has an amount in benefit at the end - think Pension.
What plan for resellers?
Firstly, you're probably going to start with a DC plan, unless you are fully loaded on that from other employment. Once the DC plan is working effectively, it is worth looking at other types of Plans. Ballpark: You're probably going to need to be over $100K before DC plan deductions to really start looking at DB/Cash Balance on the top.
What DC Plan?
SoloK, SEP IRA, Simple IRA are your real choices.
- The SoloK (Aka Individual 401k, Solo 401k) is best suited for a company with no employees - it can only cover you and your spouse.
- A SEP IRA is better suited for a small company that wants to benefit the team - note that what you extend to you as a contribution is generally what you must offer your team.
- A Simple IRA is better suited for a slightly larger company, that wants to offer a few perks and company matching like they have a 'real' 401(k) system, but with less hassle.
- SoloK $18K+$35K for $53K
- SEP IRA $53K
- Simple IRA $12.5K+$3K
The numbers in green are Employee Contributions that come from salary deferral, lowering taxes. These don't play nicely with one another. The max Employee contribution per year (2016) is $18K. This is across all accounts. The regular, employer sponsored 401(k) at your 'real' job is a green number. This means if you are putting in $17K to your work plan, you can only put in $1K on the Employee side of your small business plan (the SoloK or the Simple IRA).
The numbers in orange are Total Annual Max. This means that in theory, if you have a great employer, you could put in $18K and they could match you $35K.. or if you are self employed you can be that great employer with either a SoloK or a SEP IRA.
You can't go over the hard limits of $18K Green (Employee) or $53K total with the Employer additions. You can't have 3 401(k) plans and put away $159K... with one exception:
For those over 50 you can add a 'catch up' your Employee side contribution. For the SoloK the catch up is $6K for the Simple IRA the catch up is $3K. The SEP isn't Employee side, it is an Employer only plan, there isn't a catch up.
More Integration (Technical Stuff)
- You generally can't contribute to both a SEP IRA and a SoloK in the same year. In order to do so you have to build a tailor made SEP that avoids IRS model 5305. Even then, you'll have to fight hard to get a custodian (think Brokerage house) to touch you.
- You can integrate a SEP, SoloK, and Simple IRA with a regular (by which I mean real job) 401(k) / 403(b). But the Employee and Total limits apply.
At this point, I'm no longer talking about the Simple IRA because it is lame.
Rules for SoloK
- Salary deferral of up to $18K - reduces taxable income, pay tax on the money in retirement, or when converted to a Roth...
- Employer contribution - up to 25% of Salary if you are a Corporation (paying yourself), capped at $35K. If you are a LLC/Sole Prop it is 20% of net profits after some deductions.
- Other rules..
- For Employees, its a max of $53K based on 25% of compensation, but if you are Self Employed, it is around 18.6%, similar to the SoloK Sole Prop situation.
The SEP for the Self Employed person runs off Net Profit. You can see the worksheet here. Contrast that with the SoloK that runs off Salary. This raises interesting questions, and your Net Profit, after deductions might push you one way or the other. Note that while you cannot contribute to a SEP and SoloK in the same year, you can have both plans, so you can swap later.
SoloK can absorb profit quickly. You can direct $18K into salary, defer it into Employee side, and pay no Tax (though you still owe FICA and FUTA). You can then add an Employer 25% on top.
SEPs don't eat your 'real' 401(k) Employee side limit of $18K so if you have a good job and are maxing this out, a SEP has value over a SoloK.
Example:
You earn $13K from your Reselling gig, and you are maxed out on your 401(k) at real work. If you want to fund a SoloK you only have the Employer side available so you might pay yourself around $8K Salary (with tax!) just to be able to kick in an Employer contribution of about $2K.
Instead, if you ran with a SEP, you could deduct the heck out of the $13K (legitimately) and if you could kick in a small amount of SEP contribition, and run a very small payroll, lowering Triple tax, FICA, FUTA.
However, if you didn't have a plan at work, and you had income of say, $30K, you'd be far better off with the SoloK, maxing out the $18K on the Employee side, topping up with an Employer contribution of $4.5K, and expensing the balance, if legitimate. Tax on the $30K would be negligible.
A SEP here, barring very high expenses, would only be able to deduct around $5K, and taxes would be considerably higher.
How to set up the account
SoloK
SoloK is considered 'harder' and more complex. You'd have to run payroll to operate it, which can be $15-60 per month depending on how hands on it is. Beyond this, there are a few things happening in a SoloK plan:
The Plan papers - these outline and define the plan. You can write your own rules here based on features you want, such as allowing Roll ins, Roth elections, etc.
Plan Administration: Typically done by a TPA (Third Party Administrator)
Custodian: Where you house the funds, a Brokerage account in a trust account
Many people pay money to build a plan and have a TPA report for it, however, you don't really need to worry about this until the plan reaches $250K in assets, when form 5500 reporting is required. The reason for this is that the TPA helps with the 5500 (it isn't rocket science though).
So what happens with such a system is you pay someone to write your papers, and then you retain them to report on the plan. You can pay a lot, or a little. If you go this route, I recommend talking with Ascensus they will build your plan, you find a custodian who will work with you, and they report. Ascensus charges about $365 to establish the plan and under $100 per year to report if memory serves.
However, what you can also do is adopt what is called a 'Model' plan this is a prewritten document that covers part A of things (the paperwork to establish) but does not report annually on form 5500. I think that most people who are setting up a plan can start with such a thing, and then pivot to a Ascensus/other custom plan when assets are high, and when they are, draft in roll in terms to the new plan, so you can transfer the funds over without a tax event.
Vanguard offers such a model. You could open it for no fee, and fund it until you get near the $250K level, and pivot.
A SoloK must be established by fiscal year end, 12/31 unless you are special.
SEP IRA
A SEP is a lot easier, none of the TPA issues, and can be opened by 4/15 of the following year.
Conclusion
SEP's and Solo's are great plans - but your personal circumstances (such as how much is the green bucket) will dictate which is best. Also, while deferring taxes is great, not paying them at all is better.
Once you max out these you can look at Cash Balance or other plans, and tuck away another $58-$265K on top of your SoloK. When you do, it is important to factor in AUM vs Flat Fee custodial fees.
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