Are you a business owner with no employees? Do you want to reduce your income taxes? Would you like to contribute more than allowed with a SEP IRA? Then consider an Owner K or Owner DB Plan.
The Owner K, a type of “one-person 401(k),” is now the retirement plan of choice for many business owners with no employees other than a spouse. The Owner K plan has the highest contribution limits available for a business retirement plan while still offering the flexibility to determine contribution amounts year to year. The plan can be used by self-employed individuals, corporations and partnerships that want to maximize — with flexibility — pretax retirement contributions.
Tax law changes that became effective in 2002 allow a business to contribute up to 25 percent of compensation as a profit sharing contribution plus salary deferral contributions of up to $15,500 in 2007, so long as the total does not exceed the lesser of 100 percent of compensation or $45,000. If the person is age 50 or older before the end of the year, an additional $5,500 can be contributed as a catch-up contribution, for a total of $50,500.
If a business has no employees other than either persons owning 5 percent or more of the business and their spouses, no discrimination testing is required. In addition, the contribution limits apply to spouses independently, so both spouses may contribute the maximum allowed.
Roth Deferral Contribution can also be made. You may contribute part or all of your salary deferral amount (up to $15,500 or $20,500, if you are 50 or older by December 31, 2007) as an after-tax Roth deferral contribution, instead of a pretax traditional 401(k) contribution. Roth deferral contributions are not tax deductible, but Roth deferral amounts are distributed tax-free, if certain conditions are met.
Should you consider an Owner DB Plan, or Owner Defined Benefit Plan? Would you like to make tax-deductible retirement contributions for yourself or you and your spouse that exceed $45,000 or 25 percent of your income? Would you like to accumulate the maximum retirement assets in the shortest time possible? Are you age 40 or older?
If you answered “yes” to these questions, then the Owner DB plan may be ideal for you. The defined benefit plan is designed for businesses where the only employees are the business owner and the business owner’s spouse, and where annual earnings exceed $100,000 and are expected to continue at that rate.
The features of DB Plans include
• Contributions are tax-deductible
• Any business entity may establish an Owner DB Plan (sole proprietorship, partnership, corporation or limited-liability company)
• Earnings are tax-deferred until distribution
• Annual contributions may significantly exceed the $45,000 to $50,000 maximum contribution typical of other types of retirement plans.
You and your spouse may also make salary deferral contributions for 2007 of up to $15,500 or, if you are age 50 or older, $20,500. Your business can also make a 6 percent profit-sharing contribution.
An additional consideration for DB Plans is that defined benefit plans require annual contributions over a period of at least three years. However, if business conditions change, the plan may be amended to adjust annual contributions.
Every qualified retirement plan must file a Form 5500 annually, unless an exemption applies. If you and your spouse are the only participants in the plan, you may be subject to an exemption. However, if you own more than one business or your Owner K plan has more than $100,000 in assets in total, no exemptions will apply.
Failure to file can have significant penalties. I recommend that you consider always filing a Form 5500, even if exempt, so to maintain adequate records and to make sure you have complied. In addition, filing the Form 5500 may be beneficial in case your taxes or the plan are ever audited by the IRS. Please consult with your tax advisor as to your specific filing requirements and if an extension is available, if needed.
An Owner K or Owner DB Plan must be established by December 31, 2007 for 2007.
If you and your spouse are the only employees, you should consider the increased ability to accumulate the maximum retirement assets. Talk to a professional financial advisor to determine which plan suits you best.