04 Jun What’s the best retirement plan for my small business?

Q. My broker advised I set up a Uni-K plan for next year’s taxes. The cost is only $50 to set up. This year my retirement contribution was $6,500 to a Roth – I’m over age 50 – and $7,000 to a SEP-IRA. Does the Unit-K make sense?
— Small businessperson

A. A Uni-K, also called a Solo 401(k), Solo K or one-owner 401(k) plan, is meant for self-employed individuals with no full-time employees.

The advantage of this kind of plan is that it allows higher contributions, said Gerard Papetti, a certified financial planner and certified public accountant with U.S. Financial Services in Fairfield.

The contributions for 2019 are made up of three parts: an employee contribution of up to $19,000, a catch-up contribution of up to $6,000 for those over age 50, and an employer contribution of up to 25 percent of earnings, Papetti said.

He said contributions are capped at a maximum of $55,000 or 100 percent of pay, or $61,000 if you are over age 50.

“An employee must elect to make the employee deferral contribution by Dec. 31 of the year,” he said. “However, the employee deferral contribution can be made up until the tax-filing deadline.”

As for the employer contribution, the business may make annual profit-sharing contributions for the business owner annually, he said. Internal Revenue Code Section 401(a)(3) states that the amount of employer contributions is limited to 25 percent of the entity’s income subject to self-employment tax.

“Schedule C sole-proprietors must do an added calculation starting with earned income to determine their maximum contribution, which, in effect, brings the maximum 25 percent of compensation limit down to approximately 20 percent of net self-employment income,” Papetti said.

A step-by-step worksheet for this calculation can be found in IRS Publication 560.

In general, Papetti said, compensation is your net earnings from self-employment.

“This definition takes into account both of the following items: (i) the deduction for one-half of your self-employment tax, and (ii) the deduction for contributions on your behalf to the plan,” he said. “Note that although the Solo K plan is designed for the individual business owner or self-employed taxpayer, the plan is available to the spouse of the owner and any shareholder or partner of the business as well.”

Papetti said the Solo K plan can allow for greater annual contributions than a Simplified Employee Pension (SEP) because the first $19,000 ($25,000 for those 50 and over) is tax-deductible as employee deferrals and therefore not subject to the employer contribution limits noted above. It is the employee deferral feature that makes Solo K plans more advantageous than a SEP for maximizing contributions for the business owner, he said.

As for your specific situation, you indicated that you have a SEP for which you contributed $7,000 in 2018. The contribution limits for SEPs are the same as the employer contribution limits noted for Solo K plans, Papetti said. Therefore, unless you plan to take advantage of maximizing the employee deferral contribution, the SEP may be appropriate for your situation.

For a business owner who has significant net income and wants to shelter the maximum amount of money pre-tax, the Solo 401(k) may be the best alternative, he said.

Papetti offered this example: Let’s take a self-employed 50-year old business owner who has $100,000 of net earnings from self-employment.

Both the SEP IRA and Solo 401(k) would allow an $18,587 employer contribution calculated as follows:

• Net-earnings from self-employment before a retirement plan contribution: $100,000
• Less: ½ self-employment tax ($100,000 x .9235 x .153), a deduction of $7,065
• SEP Contribution (limited to 25 percent of net self-employment earnings: $18,587
• Net self-employment earnings after required deductions: $74,348

“The Solo 401(k) provides that in addition to the $18,587 Employer Contribution, the business owner can also make a $19,000 employee deferral contribution and an additional $6,000 catch-up contribution,” he said. “With the SEP IRA, this is not an option.”

In total, the business owner can contribute $43,587 in the Solo K plan, which is $25,000 more than a SEP IRA.

That is a significant difference and tax savings, Papetti said.

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This story was originally published on June 4, 2019.

NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.