Consulting Services
Summary of Owner-only Options
Basic Owner-only Plan Types
Plan Highlights & Candidates
A company with no employees other than the owner (or owner & spouse) has a number of options when considering the selection of a tax-favored retirement savings program, including SEP-IRAs, SIMPLE-IRAs, 401(k)s, and Defined Benefit Plans. The most powerful of these plan types tend to be the 401(k) and Defined Benefit Plans.
With regard to "for profit" companies, there are no restrictions on the type of retirement plan a type of business entity can sponsor. For example, a sole proprietorship can sponsor a 401(k) Plan, and a s-corp can sponsor a SEP. So, a "for profit" company of any type can choose from any of these retirement plan options.
| Deferral | Catch-up | Max | Administrative |
SEP | n/a | n/a | 25% or | Minimal |
SIMPLE-IRA | $11,500 | $2,500 | 2% or 3%*, | Modest |
401(k) | $16,500 | $5,500 | 25% + deferrals, | Modest |
Defined Benefit | n/a | n/a | Up to | More |
DB + 401(k) | $16,500 | $5,500 | Deferrals + DB up to | More |
*Company contributions to a SIMPLE-IRA are capped at either 2% or 3% of compensation.
**$54,500 with the addition of $5,500 catch-up if owner age 50 or older.
***Maximum DB contribution depends on age and compensation.
Basic Types of Owner-only Plans
SEP:
Contributions to a SEP are limited to the lesser of 25% of current year compensation or $49,000. This means that an owner of a corporation must receive W-2 wages of $196,000 or more to reach the $49,000 maximum.
SEP contributions are subject to many of the same limits and restrictions as qualified plans. Therefore, a company should never make contributions to a SEP in addtion to making contributions to a 401(k) or DB Plan.
401(k):
Company contributions to a 401(k) Plan are also limited to 25% of current year compensation. However, salary deferrals of up to $16,500 may be made in addition to the company contributions (up to a combined total of the lesser of $49,000 or 100% of the owner's compensation). This allows an owner of a corporation with W-2 wages of less than $196,000 to contribute more than they would have been able to using a SEP.
An owner age 50 or older may defer an additional $5,500, bringing the maximum up to $54,500.
The owner may characterize deferrals under the plan as pre-tax Roth deferrals (rather than the traditional after-tax deferrals). There is no compensation limit on the use of Roth deferrals in a 401(k) Plan, so owners can take advantage of this feature no matter what their compensation is.
If the company meets the requirements of Form 5500-EZ, a 5500-EZ need not be filed with the government until assets exceed $250,000 (please note that this asset threshold includes rollovers and contributions receivable for that year). If the company does not meet the 5500-EZ requirements, the plan must file a full Form 5500 no matter the amount of plan assets (see 5500-EZ instructions for requirements).
SIMPLE-IRA:
Deferrals under a SIMPLE-IRA are limited to $11,500 (with an additional catch-up deferral of $2,500 for owners age 50 or older). Company contributions are limited to either 3% of compensation (using the match) or 2% of compensation (using the non-elective contribution). This generally means that total contributions are far less than the $49,000 maximum for the SEP or 401(k).
SIMPLE Plans are subject to a unique rule that prevents the company from sponsoring another type of retirement plan in any calendar year that it has sponsored a SIMPLE Plan. If a company currently sponsors a SIMPLE-IRA, it must cease sponsoring the SIMPLE and wait until January 1 of the next calendar year to start a new type of plan.
Defined Benefit:
Because a DB Plan funds for a benefit at retirement, the maximum contribution is not directly limited by the owner’s compensation in the current year. Rather, what is limited is the benefit at retirement the plan may promise the owner. This retirement benefit cannot exceed the lesser of (i) 100% of the owner's highest average compensation over three consecutive years, or (ii) the COLA-adjusted dollar limit (currently, the dollar limit on retirement benefits is $195,000 per year, for retirement ages between 62 and 65).
Once the plan has established an expected benefit for the owner to be paid at the plan’s retirement age, an annual contribution schedule is calculated that would allow the plan to be fully funded when the owner reaches that age. For this reason, the closer the owner is to a reasonable retirement age, the greater the annual contributions need to be to fund that benefit (this is because there are fewer years to fund that benefit than would have been the case for a younger person).
Consider an owner, age 55 with W-2 wages of $195,000 or more, who intends to retire at age 65. These facts would allow first-year deductible contributions to the DB Plan of approximately $150,000, as follows:
- Compensation of $195,000 allows the plan to promise the owner-employee the maximum annual benefit payment beginning at retirement (in this case, $195,000 per year beginning at age 65).
- To fund this expected annual payment stream beginning at age 65, a "lump sum" of more than $2 million is needed by age 65.
- In order to build this lump sum in ten years (given assumptions regarding rate of return, etc.), contributions of approximately $150,000 per year for ten years are needed.
- This process of valuing plan benefits and calculating contributions to fund those benefits is repeated each year, so contributions fluctuate from year to year based on the actual experience of the plan.
DB Plans have contribution requirements each year. The plan must maintain enough assets to fund promised future benefits to the owner. So an increase in benefit accrual for a year generally means some contribution will be required that year to fund the benefit increase.
This also means that investment performance affects required contributions to the plan. If the investments incur a substantial loss, an increase in future contributions may be required to make up the loss. Similarly, if actual investment return exceeds the assumed rate of return used to calculate funding obligations, required contributions in future years will tend to be reduced.
The plan may be amended to lower contributions for future years; however, benefits accrued during a plan year must be funded. Therefore, an owner considering adopting a DB Plan should assume that there will be required contributions to the plan in future years.
Add a 401(k) Plan to a DB Plan:
Owner-only DB Plan contributions are not affected by a 401(k) Plan, provided that contributions to the 401(k) Plan are limited to: (i) salary deferrals, and (ii) a profit sharing contribution that does not exceed 6% of the owner's compensation. This allows the owner additional discretionary contributions of $16,500 salary deferral ($22,000 if the owner is age 50 or older), plus a 6% of compensation profit sharing contribution (not to exceed $14,700).
Plan Highlights & Candidates
SEP-IRA
- Contribution: limited to the lesser of 25% of compensation or $49,000 (2009, indexed).
- Contributions are flexible, and can range from the maximum to no contribution.
- Administrative requirements and costs: Minimal.
- Candidates:
- Owners satisfied with contributing 25% or less of compensation (not to exceed $49,000) to a retirement plan.
- An owner who wants to keep plan costs and administrative requirements to a minimum.
401(k) Plan
- Contributions:
- Company contributions are limited to 25% of covered compensation.
- Employee deferrals of up to $16,500, plus an additional $5,500 catch-up if age 50 or older (2009, indexed).
- Combined contribution limit of $49,000, or $54,500 if age 50 or older (2009, indexed).
- Employee deferrals may be designated as “after tax” Roth contributions. There is no compensation limit on the use of Roth deferrals in a 401(k) Plan.
- Contributions are flexible, and can range from the maximum to no contribution.
- Candidates:
- Owners of corporations with W-2 wages of less than $196,000 who want to contribute more than 25% of compensation, while maintaining contribution flexibility.
- Sole Proprietors with Self-Employment Income of less than $250,000 who want to contribute more than 25% of compensation, while maintaining contribution flexibility.
- An owner who wants to keep plan costs and administrative requirements low.
Defined Benefit Plan combined with 401(k) Plan
- Contributions: Defined Benefit Plan first-year contributions vary with age, service, and compensation.
- Owner of a corporation, age 40, with W-2 wages of $180,000
Total Contributions = $97,300: - $70,000 into the DB Plan
- $16,500 salary deferral into the 401(k) Plan.
- $10,800 profit sharing contribution to 401(k) Plan.
- Total of contributions
- Owner of a corporation, age 62, with W-2 wages of $100,000
Total Contributions = $212,000: - $184,000 into the DB Plan
- $22,000 salary deferral into the 401(k) Plan.
- $6,000 profit sharing into the 401(k) Plan
- Candidates:
- Age 40 or older (in most cases).
- Business income is relatively stable.
- Wants contributions in excess of 25% of compensation or $49,000 (2009 limit, indexed).
- Willing to fund the plan for at least 3-5 years.
