A SEP provides business owners with a simplified method to contribute toward their employees’ retirement as well as their own retirement savings. Contributions are made to an Individual Retirement Account or Annuity (IRA) set up for each plan participant (a SEP-IRA).
A retirement plan that you fund with post-tax income (you can’t deduct your contributions on your income taxes). After that, all future withdrawals are tax free. Unfortunately, there is no up-front tax deduction for Roth IRA contributions. The Roth IRA program also limits your contributions to $5,500 ($6,500 for catch up contributions) in 2018, making it more challenging to accumulate significant retirement savings quickly. Further, there are income limits on the Roth IRA, so it’s not for everyone. If you’re a young entrepreneur just starting out a Roth IRA might be a good fit. However, if you’re a high income self employed person age 40+ the program might not be right for you.
A defined benefit plan is a qualified plan in which you set a target annual retirement benefit — the amount you want to have each year when you retire. Then your annual contributions are calculated to provide that benefit. Contributions are based on current age, the average of your 3 highest years of income, your planned retirement age, and, in subsequent years, the balances you have accumulated in the plan. Annual contributions are mandatory, and a higher benefit will result in higher annual contributions. Contributions will increase or decrease as the 4 factors mentioned above change.
Section 415(e) of the Tax Code was repealed. Because of the repeal, a business owner can now use a defined benefit plan to build assets without taking into consideration money already accumulated in other retirement plans.
Section 415(b)(1)(A) was amended to increase the maximum retirement benefit allowed.
Section 415(b)(2)(C) was amended to lower the age at which the maximum retirement benefit could be received.
2006 Pension Protection Act provides additional flexibility by allowing contributions of no more than 6.0% to a defined contribution plan, in addition to salary deferrals, without impacting the contribution to the defined benefit plan
Together, these changes allow small business owners to contribute more now to a defined benefit plan.
In addition, the creation of new 199(A) 20% deduction as part of the new Tax Cuts & Jobs Act increases the relevancy of these plans due to their high contribution limits and potential to reduce Qualified Business Income (QBI). This in turn may allow a high income self employed individual or small business owner to take advantage of the new 199(A) deduction.
Qualified retirement plans such as the SEP, 401(k), Defined Benefit plan and Cash Balance plan reduce taxable income, which lowers the total taxes owed. In 2018, Defined Benefit and Cash Balance plans offer the largest contribution limits amongst qualified retirement plans at $220,000.
You can easily calculate contribution and tax savings with this easy to use Defined Benefit calculator