You read that correctly but, it’s more likely your retirement adviser is really a salesmen for a company that is trying to make money by investing your money. Good return or bad return, they get paid. But, for the small business owner, there are so many products out there to choose from, rare is the retirement account salesmen not in bed with one of the investment companies. Nonetheless, this post is for business owners who want to avoid paying taxes by saving for their future or want to save in alternative investments (gold, real estate, art, etc.). Avoidance by the IRS is fine. Evasion is not-so-fine. While, there is a little bit of a grey line as to what is avoidance and evasion, these plans are 100% legit and legal. The government wants you to save money and therefore has provided these generous tax benefits. So let’s start avoiding taxes:
- SEP-IRA. This is an IRA for the owner of a business. It will allow you to save up to $50,000 per year. Not to bad. At the highest rate of tax, that saves you $18,500.00 in tax. Most people do not pay 37% (as of 2018) so it most likely saves you about $12,500. This is the most basic model and should be used for anyone who is beginning a business and wants a safe, easy way to sock away money. But, contributions to the plan are limited to 25% of compensation. Therefore, you can only contribute 25% of your income. Thus, to max it out, you’d have to pay yourself $200,000 in payroll and you don’t want to pay yourself that much because you’re going to be paying large amounts of payroll taxes on your salary. So, perhaps there’s a better way.
- 401(k) + Profit Sharing Plan. This allows $18,500 of your compensation to go into the 401(k) plan and then 25% of your compensation, up to $250k, so another $62,500. This would give you the ability to put away $81,000. Better than the last plan and sometimes in an S Corporation you have to pay yourself a larger salary so that you are paying yourself a “reasonable” salary, and in that case this makes the most sense. But, see the next paragraph.
Both of the above plans become severally limited when you have employees. If you have employees, you cannot contribute to your own account and leave your employees in the dust. The more employees you have the more this becomes more and more expensive. If however, you are doing business by yourself, they work just fine.
- Solo Defined Benefit Plan. This is funded 100% by the company. Is a tax deduction by the company and is not income to you. It also allows the company to contribute up to $255,000 if the employee is in their 50s. The contribute limit is based on a person’s age and how long they have to retirement. These plans are more expensive, and there’s still an employee issue (which I addressed above but to which I’ll explain how to fix below). But, $255,000 is much, much higher than $81,000 and will save you about $92,500 in taxes at the highest rate.
- Self-Directed IRA – For the truly adventurous. You could open a self-directed SEP IRA with a profit sharing plan. That puts $68,500 tax free dollars at your disposal. The difference is in the other accounts you must buy stocks and bonds and such and perhaps you would actually like to use this money to invest in a) real estate, b) new companies you create, c) bitcoin, d) art, e) jewelry, etc. You can use the money to purchase real estate, like a house or lot, and if you live there you could pay yourself rent and the money accumulating in the retirement account is tax free and its yours later. Or, perhaps you need capital to start your new business. Your new company could sell shares to your IRA, and boom! You’ve got the capital you need and when the company sells or distributes a dividend, that money goes to the IRA and is not taxable. Lastly, you could be on the forefront of investing in the internet of money, Bitcoin, and can do that. It’s your risk and your reward.
What this post is really trying to tell you is that you cousin’s Edward Jones adviser isn’t the only game in town. Do your research and find what fits for you.
So how do you deal with the employee issue as stated above? It involves using separate companies, some with the labor, some without and bifurcating your intellectual property and creating a holding company. All to be explained in a later post.
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