Choosing the best type of retirement savings plan to establish for your business can determine how large a contribution you are eligible to make and thus how great your tax savings can be and ultimately, how large your retirement savings will grow. Different plans require varying amounts of income to make a maximum contribution. The two most popular retirement plans for the CRE broker are the SEP-IRA and the Individual 401(k) plan. Depending on your situation and funding goals, one may be more appropriate than the other.
Both types of plans are established by employers and the self-employed. SEP-IRAs have contributions made exclusively by the employer while Individual 401(k)s have an employee contribution and employer profit sharing contribution.
SEP-IRAs became popular because they are simple to establish and maintain. They can also be created after the tax year has come to a close. Your CPA may have recommended this plan to you while preparing your prior year’s tax return.
The Individual 401(k) plan is similarly simple to establish and maintain. However, it needed to be established before the end of the tax year in order to fund. Because of this, it probably impacted how many brokers decided to start retirement savings with this plan type. Fortunately, the recently passed SECURE Act has brought the establishment deadline in sync with SEP-IRAs.
As a sole proprietor, the deadline for contributions is the tax return due date. However, if you file as an S-corp, the employee contribution deadline is year-end while the employer profit sharing contribution deadline is the tax return due date.
For 2020, contribution limits for both are $57,000. However, the Individual 401(k) also allows for a catch-up contribution of $6,500 for those age 50 and older, while the SEP-IRA does not. While the contribution limits are similar between the two plan types, the calculation for determining contributions can be dramatically different. The most extreme differences are for the sole proprietor, whose SEP-IRA contributions are generally limited to 20% of net income reduced by the deductible amount of self-employment taxes.
Thus, a broker earning $100,000 a year could contribute $18,857 to a SEP-IRA but $37,587 to an Individual 401(k) – a $19,500 employer contribution plus an $18,087 employer profit sharing contribution. Additionally, the $6,500 catch up contribution is also available to those age 50 and older. The same broker earning half can contribute only $9,293 to a SEP-IRA but $28,793 total to an Individual 401(k). This difference is because the employee contribution remains the same in an Individual 401(k) plan even when income is low. The employee contribution this year is $19,500, so as long as you earn slightly more than that, you will still be able to contribute $19,500 to the 401(k). The SEP IRA will be dramatically lower.
What about the differences when your goal is to contribute the maximum? With an Individual 401(k) plan, the sole proprietor will have to earn just under $200,000 to contribute the maximum amount. To reach the maximum contribution for a SEP-IRA, this same broker will have to earn almost $293,000.
Another reason to consider an Individual 401(k) plan over a SEP-IRA is because it allows for Roth IRA contributions and preserves your ability to make “backdoor” Roth IRA contributions, as discussed in a previous post. You do not have to try to determine which plan is best for you. Contact us and we will be happy to help you evaluate your choices.
