Retirement Plans for Resellers

Matt

Administrator
Staff member
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.

  • 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.
Some plans merge the lines. A notable one is a Cash Balance plan.

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.
Limits
  • SoloK $18K+$35K for $53K
  • SEP IRA $53K
  • Simple IRA $12.5K+$3K
Integration

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.
The Rules

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..
Rules for SEP IRA
  • 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.
Considerations

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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RWC75

Level 2 Member
For SEP IRAs, the maximum contribution is still limited to 25% of compensation correct? So where is the advantage there over the Solo 401k? The employer pre-tax contribution for both is 25% of compensation?
 

Matt

Administrator
Staff member
For SEP IRAs, the maximum contribution is still limited to 25% of compensation correct? So where is the advantage there over the Solo 401k? The employer pre-tax contribution for both is 25% of compensation?
SEP can run off net profit - doesn't need you to create the payroll. It's all employer side and not dependant on W2. W2 income is not good, anything over $5040 is wasteful, unless you can later drop it with deductions.

[What you are doing/thinking of doing in the other thread is create a bunch of payroll taxes in order to facilitate some Employer side.]

Once you hit higher income, SoloK can be maxed at $140K Salary. Whereas a SEP would need to be higher ($212K on Salary, and higher again if run on net profit) so the SoloK at higher levels can be smart, because if you run a Corp (S or C) you can divert money from W2 with the Solo.

If you are at a lower level of income from the side gig, but are maxing out 401(k) at work, I'd look strongly into deductions first, followed by SEPs. The topping up Employer side only or mega non deductible Employer side things aren't as hot as it might appear, they have complexities attached (step doctrine etc) but more than anything, you find yourself falling over to load a retirement account (that is later taxable) and creating tons of tax to do so...

SoloK and SEP really aren't the same, don't be deceived by the numbers of 25/25 (or 20ish for self employed) being close. But also your decision should be just on Apple to Orange, it should be how each fits into your system (the Corp vs Pass through) and the deductions.
 

sound48

Level 2 Member
It's funny you posted this as I was just talking to Fidelity yesterday about a SEP and Solo K. Please correct me if I'm wrong as I'm very much a novice in this department. I was also talking to them concerning an scorp. It sounded like once you get to 265k in profit, the SEP would be the better option, less of a headache and easier to manage. Until then, the Solo K gives you a better short-term option. However, all the headaches associated with a Solo K, including the fact that you're stuck with the Solo K from that point on make it a bad option, especially if you see the business growing and want to hire employees.
 

Matt

Administrator
Staff member
It's funny you posted this as I was just talking to Fidelity yesterday about a SEP and Solo K. Please correct me if I'm wrong as I'm very much a novice in this department. I was also talking to them concerning an scorp. It sounded like once you get to 265k in profit, the SEP would be the better option, less of a headache and easier to manage. Until then, the Solo K gives you a better short-term option. However, all the headaches associated with a Solo K, including the fact that you're stuck with the Solo K from that point on make it a bad option, especially if you see the business growing and want to hire employees.
You're fine. You need to understand that the level of knowledge of most of the guys at Fidelity or the other houses isn't good. When examining who would custody a SoloK or who would write or custody a non 5305 SEP I've spoken with most of these guys, and the real expert teams on the matter are literally 1-2 people within each company. Think of a firm like Fidelity of Schwab, there's two people in each who know this properly..

The vibe is that a Solo K is a PITA. But it really isn't that much to worry about. Ascensus et al will run the admin of it for you. Reporting isn't that hard. This comes from people opening the accounts who click buttons vs send through plan documents to compliance for approval. They would say one is easier than the other.

Now.. the important things are this:

1. If you are well on your way to the $265K profit, you might well be able to drop taxes by 4-5 figures more by SoloK (assuming you aren't loading up that employee side with a real job). This matters a lot.
2. You can swap. Start with a SoloK at Vanguard for no charge/no effort, max it out for 4 years plus some growth and you hit $250K where 5500 reporting kicks in, pivot. You're more likely to be hitting $265K profit in year 5 than year 1 or 2, and year 1 or 2 you can save the extra 4-5 figures per above.
3. $265K 'profit' is a very confusing term. $265K income is one thing. $265K net after purchase price (semi COGS) is something else.. at that level, with an S Corp and proper deductions, a SoloK blows a SEP out of the water. $265K coming into your bank after you've deducted the crap out of everything, including $53K of retirement account is a whole different ballgame.
 
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RWC75

Level 2 Member
OK, I suppose I'm confused. Walk me through this, please.

I have 10k in net profit from the business (does structure matter? S corp vs. LLC vs. Sole Prop?) What is the maximum I can push to a SEP IRA?

My understanding is that it would be 20% of net profit, or 2k, and the remaining 8k would be handled as income of some kind. Which is the same as if I had a Solo 401k, where I'd be contributing 2k as an employer contribution and paying myself the other 8k.

That's where I'm getting lost. I don't see how you can contribute more than 20% of the net profit as a pretax employer contribution to either plan.
 

Matt

Administrator
Staff member
OK, I suppose I'm confused. Walk me through this, please.

I have 10k in net profit from the business (does structure matter? S corp vs. LLC vs. Sole Prop?) What is the maximum I can push to a SEP IRA?

My understanding is that it would be 20% of net profit, or 2k, and the remaining 8k would be handled as income of some kind. Which is the same as if I had a Solo 401k, where I'd be contributing 2k as an employer contribution and paying myself the other 8k.

That's where I'm getting lost. I don't see how you can contribute more than 20% of the net profit as a pretax employer contribution to either plan.
You might be right for your case, but I think you are approaching this with the mindset of 'what is the most I can contribute to a plan'. Whereas I would approach it as 'what is the least tax I can possibly pay, and what plan fits into that'. A plan is a tool, a mileage deduction is a tool, a home office expense is a tool. Buying a car and deducting $60K is a tool. Big picture, you don't want as much in a retirement account as possible, you want to pay as little tax ever as possible. Creating tax (on the salary) for the sake of the SoloK isn't a great option, and should be a last recourse.

The net profit aspect is a huge part of this - people often don't know what they can deduct, and may think that after earning $20K in FBA from $10K purchased inventory their net profit is $10K. However, for 'net profit' as is often discussed to be '$10K.. what do I do with it' you might well find people up in the $30 - 40K of income from the $10K purchased inventory.

As such, if you are in this realm of $10K 'net profit' you probably want to focus on ways to drop that profit down by any means other than taking a salary option first, and if you can, the SEP becomes more valuable. If you really can't drop it, then both are similar.

Hard to say without seeing everything, but I think this profit reduction might be something to look into further for most people in this situation.

*note for others the employee bucket in this discussion is maxed out.
 

RWC75

Level 2 Member
The net profit aspect is a huge part of this - people often don't know what they can deduct, and may think that after earning $20K in FBA from $10K purchased inventory their net profit is $10K. However, for 'net profit' as is often discussed to be '$10K.. what do I do with it' you might well find people up in the $30 - 40K of income from the $10K purchased inventory.
Aha! Ok that makes a lot more sense then.

So your perspective is that tax minimization is the primary goal, thus increasing net after-tax funds. Which is why things like S-Corp structures with their ability to reimburse at rates higher than actual cost (fixed cost per square foot of office space, per diem M&I rates, etc) as well as lower taxes on Distributions vs. W2 income are so high on your list of priorities. Makes a lot more sense now.

I'm going to have to sit down at some point and get a decent accountant to look at my books, see what else I can do on that front. You're probably right that rethinking my business structure makes a lot of sense.

Thanks for the inspiration and for your patience.
 

CWAL

Level 2 Member
Matt, I'd be very interested in hearing more about the defined benefit plans.

Is there a significantly increased ability to defer profits from taxation? How flexible are they on the payout setup? I'd imagine they have higher admin costs though, and this is why you recommended them only for $100k+.
 
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