FAQs – Owner-Only Plan Options
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What are Owner-Only plan options?
The most powerful of these plan types tend to be the 401(k) and Defined Benefit Plans.
There are few restrictions on the type of retirement plan a particular 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 company of any type can choose from any of these retirement plan options.
|Deferral||Catch-up||Max Contribution||Administrative Requirements|
*Company contributions to a SIMPLE-IRA are capped at either 2% or 3% of compensation.
|SEP||n/a||n/a||25% or $55,000||Minimal|
|SIMPLE-IRA||$12,500||$3,000||2% or 3%*, plus deferrals||Modest|
|401(k)||$18,000||$6,000||$55,000 or $61,000**||Modest|
|Defined Benefit||n/a||n/a||Up to about $250,000***||Most|
|DB+401(k)||$18,000||$6,000||Deferrals + DB up to about $250,000***||Most|
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What are the features of an Owner-Only SEP?
- Limited to the lesser of 25% of compensation or $55,000 (2018, indexed).
- Flexible, and can range from the maximum to no contribution.
- Administrative requirements and costs are minimal.
- Owners satisfied with contributing 25% or less of compensation (not to exceed $55,000) to a retirement plan.
- Owners who want to keep plan costs and administrative requirements to a minimum.
Contributions to a SEP are limited to the lesser of 25% of current year compensation or $55,000. This means that an owner of a corporation must receive W-2 wages of $220,000 or more to reach the $55,000 maximum.
SEP contributions are subject to many of the same limits and restrictions as qualified plans. Therefore, a company generally should not make contributions to a SEP in addition to making contributions to a 401(k) or DB Plan.
What are the features of an Owner-Only 401(k)?
- Company contributions are limited to 25% of covered compensation.
- Employee deferrals of up to $18,500, plus an additional $6,000 catch-up if age 50 or older (2018, indexed).
- Combined contribution limit (that is, deferral and company contributions) of $55,000, or $61,000 if age 50 or older (2018, 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 allowed to no contribution.
- Owners of corporations with W-2 wages of less than $220,000 who want to contribute more than 25% of compensation, while maintaining contribution flexibility.
- Sole Proprietors with Self-Employment Income of less than about $280,000 who want to contribute more than 25% of net Self-employment Income, while maintaining contribution flexibility.
- An owner who wants to keep plan costs and administrative requirements low.
Company contributions to a 401(k) Plan are limited to 25% of current year compensation. However, salary deferrals of up to $18,500 may be made in addition to the company contributions (up to a combined total of the lesser of $55,000 or 100% of the owner’s compensation). This allows an owner of a corporation with W-2 wages of less than $220,000 to contribute more than they would have been able to using a SEP.
An owner age 50 or older may defer an additional $6,000, bringing the maximum up to $61,000.
The owner may characterize deferrals under the plan as after-tax Roth deferrals (rather than the traditional pre-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-SF no matter the amount of plan assets (see 5500-EZ instructions for requirements).
What are the features of an Owner-Only Defined Benefit plan?
This information about Defined Benefit Plans is general in nature, and is not intended to be taken as a comprehensive description of the regulations covering qualified plan sponsorship.
- Maximum contributions generally exceed that available with a SEP or owner-only 401(k) Plan.
- Each year’s contributions are actuarially calculated, and the contribution range will vary from year to year.
- Clients should assume there will be required contributions each year.
- If the clients wants to change the contribution target, the plan document must be amended to modify the plan’s benefit accrual formula prior to benefit accrual for that year (otherwise, the modification would take place after the amendment; generally in the next year).
- Age 40 or older (in some cases younger).
- Business income is relatively stable.
- Desire to make contributions in excess of that available with a SEP or 401(k) Plan.
- Willing to sponsor the plan for at least 5 years.
Benefit Accrual Formula
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 that 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 (in 2018, the dollar limit on retirement benefits is $220,000 per year for retirement ages between 62 and 65).
Annual Contributions – Based on Annual Funding Calculations
Once the plan has established a benefit for the owner to be paid at the plan’s retirement age, a contribution schedule for that year is calculated that would allow the plan to stay on track to be fully funded when the owner reaches that age. For this reason, the closer the owner is to the plan’s retirement age when the plan is started, 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).
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 the current year generally means some contribution will be required in the current year to fund the benefit increase.
The Effect of Investment Performance
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 in the current and prior years 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.
Why add a 401(k) to a Defined Benefit plan?
This combined program both increases the maximum contributions to the program and adds some contribution flexibility, because the 401(k) contributions are not required in any given year.
DB 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 = $98,300:
- $70,000 into the DB Plan
- $18,500 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 = $213,000:
- $184,000 into the DB Plan
- $24,500 salary deferral into the 401(k) Plan
- $6,000 profit sharing into the 401(k) Plan