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Retirement Planning Within Your Small Business

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Last updated: 25 Nov, 2018
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By Jason Watson ()
Posted November 23, 2018

Most people have a pretty good handle on personal finance and basic retirement savings, and while the principles are generally the same in the small business world, a lot of business owners have a deer caught in your headlights at 2:00AM look when it comes to leveraging their business for retirement. And there is good reason- retirement planning within your small business carries a bunch more options and potential pitfalls (sounds like life in general, doesn’t it?).

Reasons for Small Business Financial Planning
There are three major wealth considerations for small business owners (or anyone for that matter)-

  • Accumulation (fun and exciting part)

  • Preservation (the tricky part)

  • Transfer (the necessary evil part)

Each of these major wealth considerations are interwoven, needs comprehensive focus to ensure the necessary dots are connected, and should have no gaps or holes exist during transitions. That is where financial planning comes into play.

Accumulation is easy. Most people think if they toss some money at a mutual fund they are planning for retirement. Nope.

Preservation gets tricky since we need to have our money outlast our lives. And with people living well into their 90s, this can be tough. Let’s put it another way- if you work for 40 years, from age 25 to 65, you need to save enough to live for another 25-30 years. That is incredible. If you are spending $100,000 at age 55, you better be making $180,000 and putting the $80,000 into a moderate growth retirement vehicle.

Preservation also includes proper insurance, asset protection through trusts, pro-active maneuvering and other tools in the toolbox.

Transfer of wealth is automatic. We have yet to see a hearse with a trailer hitch. Or, said in a completely more stark way, every life comes with a death sentence. How it is executed is partially up to you. Did we just ruin your appetite? Sorry.

Transfer of wealth can also be tricky. Current Federal estate tax exemption is $11.4 million (2019) per person, and a passed spouse can posthumously port his or her exemption to the surviving spouse. Not bad. And most people don’t have over $22.8 million (2019) in estate value. Rich people problems (now referred to as high net worth).

These Federal exemption amounts are indexed each year, and while Congress can always vote to repeal, this estate tax exemption was written in stone with passing of the American Taxpayer Relief Act of 2012. However, various states have much lower exemptions. Oregon for example is $1M and New Jersey is $600,000. Nebraska has a sliding scale. So, just because you are out of woods Federally, doesn’t mean the transfer your wealth is free of taxation. Get a plan.

What about your business? Does it have an exit strategy or wealth transfer strategy? Add this to the plan.

The reasons for financial planning are-

Goals and Objectives
Define your goals and objectives, determine your current position and discover unmanaged risks. This sounds simple and makes sense, but defining goals and objectives is a fluid concept. They change. And as they change, the plan needs to be malleable enough to adapt. Financial plans are modified annually or whenever a major life change as occurred, whichever is more frequent. This is important.

The Plan
Financial plans also create a blueprint and chart a course on how to get reach goals and objectives while managing risk. Again, this sounds simple. But even the most basic house needs a blueprint for framers, plumbers, electricians and even inspectors to review and implement. And in the case of a financial plan, these same players are your financial advisors, tax professionals, attorneys and insurance specialists.

Accountability
Financial plans also provide confidence, measure success and hold everyone accountable. If everyone agrees that your financial plan will ensure financial security in your life, then it becomes a measuring stick for determining success along the way. Anyone can throw some money at an investment, but what does it mean? And does it fit the plan? And is the selection of that investment meet the plan’s objectives.

The Watson CPA Group can always assist you with retirement and financial planning as it relates to your small business and taxation. And if you need a referral for a financial advisor we can offer that too.

Small Business Retirement Plans Comparison
We are going to put the carriage in front of the horse, and show you a comparison of basic small business retirement plans before explaining each plan. We cheated, and used Yahoo! Finance’s online calculator to demonstrate these differences. Why re-invent the wheel? And frankly, Bankrate.com does a fantastic job at this type of stuff. Here is their link-

www.wcgurl.com/6103

We took a handful of salaries (for corporations) and net incomes (for sole proprietors and partners in partnerships) and plugged them into Bankrate’s calculator, and came up with the following table based on 2019 limits-

Salary/Income

Entity

Max 401k

Max SEP IRA

Max SIMPLE

40,000

Sole Prop

26,435

7,435

14,083

40,000

Corporation

29,000

10,000

14,200

 -

60,000

Sole Prop

19,000

11,152

14,624

60,000

Corporation

34,000

15,000

14,800

 -

80,000

Sole Prop

33,870

14,870

15,165

80,000

Corporation

39,000

20,000

15,400

 -

148,000

Sole Prop

46,556

27,556

17,013

148,000

Corporation

56,000

37,000

17,440

 -

175,000

Sole Prop

51,884

32,883

17,789

175,000

Corporation

56,000

43,750

18,250

 -

196,000

Sole Prop

56,000

37,027

18,392

196,000

Corporation

56,000

49,000

18,880

 -

224,000

Sole Prop

56,000

42,552

19,197

224,000

Corporation

56,000

56,000

19,720

 -

293,000

Sole Prop

56,000

56,000

21,155

293,000

Corporation

56,000

56,000

21,400

Note the bolded $56,000 number. This is the maximum defined contribution amount permitted in 2019 per plan (and Yes you can have two plans- we’ll talk about Greg and his two plans in an example later).

Crazy! Some quick observations-

  • In 2019, the maximum you can contribute to a qualified retirement plan is $56,000. You can go above this with a defined benefits pension (cash balance)- more on that later.

  • Partnerships (those required to file Form 1065) follow the same limits as Sole Prop above.

  • $148,000 in W-2 salary from your C Corp or S Corp is the magic number for maximizing your 401k. After that, any increase in salary does not help. Your fastest way to reach your contribution limit is through a 401k plan.

  •  $224,000 in W-2 income from your S Corp is the minimum salary for a max SEP IRA contribution.

  • $293,000 from your small business or K-1 partnership income from your Schedule E as reported on your individual tax return is the magic number for maximizing your SEP IRA contribution. SEPs are old school and used for crisis management rather than planning (more on that too).

  • Earned income from a sole proprietor is net profit minus 50% of your self-employment tax minus your contribution. Since the contribution actually adjusts the maximum contribution, this can be a circular reference. And No, 401k or SEP contributions do not reduce SE tax.

  • 401k max is computed by taking $19,000 employee (you) contribution, plus 25% of your W-2 or earned income (as adjusted).

  • SEP IRA max is computed by taking 25% of your W-2 or earned income (as adjusted).

  • Max SIMPLE 401k is basically $13,000 plus 3% of your W-2 or earned income (as adjusted). Don’t spend too much time thinking about SIMPLE 401k plans.

  • You can add $6,000 for catchup contributions if you are 50 years old or older.

Let’s talk about each of these qualified plans in turn, starting with the 401k. Out of the box, or non-traditional retirement plans will follow (profit sharing plans, defined benefits pensions, cash balance plans, Section 79 plans, etc.). Exciting!

Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition
This KB article is an excerpt from our book which is available in paperback from Amazon, as an eBook for Kindle and as a PDF from ClickBank. We used to publish with iTunes and Nook, but keeping up with two different formats was brutal. You can cruise through these KB articles, click on the fancy buttons below or visit our webpage which provides more information at-

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www.watsoncpagroup.com/book

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