The IRS announced new contribution amounts for retirement accounts in 2018 and there are some winners and losers in the bunch. The biggest win goes to 401(k) owners, including solo K owners, who saw employee contribution amounts go from $18,000 to $18,500. Health savings account owners got a small victory with individual contribution maximums increasing $50 to $3,450 and family contribution amounts increasing $150 to $6,900. IRA owners don’t get a win with no increase in the maximum contribution amount for Traditional or Roth IRAs. The IRA maximum contribution amount is still $5,500 and hasn’t increased since 2013.
Here’s a quick breakdown on the changes.
– 401(k) contributions also increased on the employee and employer side. Employee contribution limitations increased from $18,000 to $18,500 for 2018. The additional catch-up contribution for those 50 and older stays the same at $6,000. The annual maximum 401(k) (defined contribution) total contribution amount increased from $54,000 to $55,000 ($61,000 for those 50 and older).
– HSAs contribution limits increased ($50 indiv/$150 fam) from $3,400 individual and $6,750 family to $3,450 individual and $6,900 family.
– IRA contribution limitations (roth and traditional) stayed at $5,500 as did the $1,000 catch-up amount for those 50 and older.
There were additional modest increases to defined benefit plans and to certain income phase-out rules. Please refer to the IRS announcement for more details here.
These accounts provide tax advantageous ways for an individual to either save for retirement or to pay for their medical expenses. If you’re looking for tax deductions, you should determine which of these accounts is best for you. Keep in mind there are qualification and phase out rules that apply so make sure you’re getting competent advice about which accounts should be set up in your specific situation.
Many Americans wonder when they should convert their IRA or 401(k) to Roth? If you have a traditional IRA or 401(k), then that money grows tax-deferred and you pay tax on the money as it is drawn out at retirement. On the other hand, Roth IRAs and 401(k)s grow and come out tax-free at retirement. Who could argue with that? Yet, most Americans have been sucked into traditional IRAs and 401(k)s because we get a tax deduction when we put the money in a traditional account, saving us money on taxes now.
For more on the differences between Roth IRA and Roth 401(k), take a look at the video from my Partner Mark J. Kohler:
The good news is that you can convert your traditional IRA to a Roth IRA, or your traditional 401(k) to a Roth 401(k). The price to make that conversion is including the amount you convert to Roth as taxable income for the year in which you make the conversion. So, if I convert $100K from my traditional IRA to a Roth IRA in 2017, I will take that $100K as income on my 2017 tax return, then pay any federal and state taxes on that income depending on my 2017 tax bracket. Many retirement account owners want to move their traditional funds to Roth, but don’t like the idea of paying additional taxes to do so. I get it. Nobody likes paying more taxes now, even if it clearly saves you more as your account grows and the entire growth comes out tax-free. Here are three cut-and-dry situations of when you should definitely convert your traditional IRA or 401(k) funds to Roth:
Up-Side Investment Opportunity – I’ve had numerous clients over the years convert their traditional funds to Roth before investing their account into a certain investment. They’ve done this because they’ve had a tremendous investment opportunity arise where they expect significant returns. They’d rather pay the tax on the smaller investment amounts now, so that the returns will go back into their Roth IRA or 401(k), where it can grow to an unlimited amount and come out tax-free. These clients have invested in real estate deals, start-ups, pre-IPOs, and other potentially lucrative investments. So, if you have an investment that you really believe in and will likely result in significant returns, then you’re far better off paying a little tax on the amount being invested before the account grows and returns a large profit. That way, the profit goes back into the Roth and the money becomes tax-free.
Low-Income Year – Another situation where you should covert traditional funds to Roth is when you have a low-income tax-year. Since the pain of the conversion is that you have to pay tax on the amount that you convert, you should convert when you are in a lower tax bracket to lessen the blow. For example, if you are married and have $75K of taxable income for the year and you decide to convert $50K to Roth, you will pay federal tax on that converted amount at a rate of 15% which would result in $7,500 in federal taxes. Keep in mind that you also pay state tax on the amount that you convert (if your state has state income tax), and most states have stepped brackets where you pay tax at a lower rate when you have lower income. If you instead converted when you were in a high-income year, let’s say $250K of income, then you’d pay federal tax on a $50K conversion at a rate of 33% which would result in federal taxes of $16,500. That’s more than twice the taxes due when you are in a lower-income year. Now, you may not have taxable income fluctuations. But, for those who are self-employed, change jobs and have a loss of income, or have investment losses where taxable income is lower than normal for a year, you should think about converting your retirement funds to Roth. You may not have a more affordable time to get to Roth.
Potential Need for a Distribution After Five Years – One of the perks of Roth accounts is that you can take out the funds that are contributed or converted after five years without paying tax or the early withdrawal penalty (even if you aren’t 59 1/2). For Roth conversions, the amount you convert can be distributed from the Roth account five years after the tax year in which you converted. The five-year clock starts to tick on January 1st of the tax year in which you convert, regardless of when you convert within the year. So, if you converted your traditional IRA to a Roth IRA in November 2017, then you could take a distribution of the amounts converted without paying tax or penalty on January 2nd, 2022. If you try to access funds in your traditional IRA or 401(k) before you are 59 1/2, then you will pay tax and a 10% early withdrawal penalty even if the amounts you distribute are only the contributions you put in, not the investment gains. Clearly, the Roth account is much more accessible in the event you need personal funds. Keep in mind, you don’t get this perk immediately: You have to wait 5 years from the tax year in which you converted before you can take out the converted amount tax and penalty free.
One final thought to consider when converting to a Roth IRA: The IRS allows you to undo the conversion if you later decide that it was a bad idea (e.g. you can’t pay the taxes and don’t want a payment plan with the IRS). What happens is the converted funds go back to the traditional account, and the converted amount is removed from your taxable income. This process is known as a Roth Re-Characterization, and you can learn more about it in my prior article here.
Solo 401(k)s have become a popular retirement plan option for self-employed persons. Unfortunately, many of the plans are not properly maintained and are at the risk of significant penalty and/or plan termination. If you have a Solo 401(k), you need to ensure that the 401(k) is being properly maintained. Here’s a quick checklist to make sure your plan is on track.
Is the Plan Up-to-Date? The IRS requires all 401(k) plans, including solo 401(k)s, to be amended at least once every 6 years. If you’ve had your plan over 6 years and you’ve never restated the plan or adopted amendments, it is not compliant and upon audit you will be subject to fines and possible plan termination (IRS Rev Proc 2016-17). If your plan is out of date, your best option is to restate your plan to make sure it is compliant with current law. On average, most plan documents we see update every 2-3 years as the laws effecting the plan documents change.
Are You Properly Tracking Your Plan Funds? Your solo 401(k) plan funds need to be properly tracked and they must identify the different sources for each participant. For example, if two spouses are contributing Roth 401(k) employee contributions and the company is matching traditional 401(k) dollars, then you need to be tracking these four different sources of funds, and you must have a written accounting record documenting these different fund types.
Plan Funds Must Be Separated by Source and Participant. You must maintain separate bank accounts for the different participants’ funds (e.g. spouses or partners in a solo K), and you must also separate traditional funds from Roth funds. In addition, you must properly track and document investments from these different fund sources so that returns to the solo 401(k) are properly credited to the proper investing account.
Does Your Solo 401(k) Need to File a Form 5500? There are two primary situations where you may be required to file a Form 5500 for your solo 401(k). First, if your solo 401(k) has more than $250,000 in assets. And second, if the solo 401(k) plan is terminated (regardless of total asset amount). If either of these instances occur, then the solo 401(k) must file a Form 5500 to the IRS annually. Form 5500 is due by July 31 of each year for the prior year’s plan activity. Solo 401(k)s can file what is known as a 5500-EZ. The 5500-EZ is a shortened version of the standard Form 5500. Unfortunately, the Form 5500-EZ cannot be filed electronically and must be filed by mail. Solo 401(k) owners have the option of filing a Form 5500-SF on-line through the DOL. The on-line filing is a preferred method as it can immediately be filed and tracked by the plan owner. In fact, if you qualify to file a 5500-EZ, the IRS/DOL allow you file the Form 5500-SF on-line but you can skip certain questions so that you only end up answering what is on the shorter Form 5500-EZ.
Are You Properly Reporting Contributions and Rollovers? If you’ve rolled over funds from an IRA or other 401(k) to your solo 401(k), you should’ve indicated that the rollover or transfer was to another retirement account. So long as you did this, the company rolling over the funds will issue a 1099-R to you, but will include a code on the 1099-R (code G in box 7) indicating that the funds were transferred to another retirement account, and that the amount on the 1099-R is not subject to tax. If you’re making new contributions to the solo 401(k), those contributions should be properly tracked on your personal and business tax returns. If you are an s-corp, your employee contributions should show up on your W-2, and your employer contributions will show up on line 17 of your 1120S s-corp tax return. If you are a sole prop, your contributions will typically show up on your personal 1040 on line 28.
Make sure you are complying with these rules on an annual basis. If your solo 401(k) retirement plan is out of compliance, get with your attorney or CPA immediately to make sure it is up-to-date. Failure to properly file Form 5500 runs at a rate of $25 a day up to a maximum penalty of $15,000 per return not properly filed. You don’t want to get stung by that penalty for failing to file a relatively simple form. The good news is there are correction programs offered for some plan failures, but don’t get sloppy, or you’ll run the risk losing your hard-earned retirement dollars.
Many self-directed investors have the option of choosing between a self-directed IRA or a self-directed solo 401k. Both accounts can be self-directed so that you can invest into any investment allowed by law such as real estate, LLCs, precious metals, or private company stock. However, depending on your situation, you may choose one account type over the other. What are the differences? When should you choose one over the other?
Must be an individual with earned income or funds in a retirement account to rollover.
Must be self-employed with no other employees besides the business owner and family/partners.
$5,500 max annual contribution. Additional $1,000 if over 50.
$53,000 max annual contribution (it takes $140K of wage/se income to max out). Contributions are employee and employer.
Traditional & Roth
You can have a Roth IRA and/or a Traditional IRA. The amount you contribute to each is added together in determining total contributions.
A solo 401(k) can have a traditional account and a roth account within the same plan. You can convert traditional sums over to Roth as well.
Cost and Set-Up
You will work with a self-directed IRA custodian who will receive the IRA contributions in a SDIRA account. Most of the custodians we work with have an annual fee of $300-$350 a year for a self-directed IRA.
You must use an IRS preapproved document when establishing a solo 401k. This adds additional cost over an IRA. Our fee for a self-directed and self-trusteed solo 401(k) is $1,200.
An IRA must have a third party custodian involved on the account (e.g. bank. Credit union, trust company) who is the trustee of the IRA.
A 401(k) can be self trustee’d, meaning the business owner can be the trustee of the 401(k). This provides for greater control but also greater responsibility.
A self-directed IRA is invested through the self directed IRA custodian. A self-directed IRA can be subject to a tax called UDFI/UBIT on income from debt leveraged real estate.
A Solo 401(k) is invested by the trustee of the 401(k) which could be the business owner. A solo 401(k) is exempt from UDFI/UBIT on income from debt leveraged real estate.
Keep in mind that the solo 401(k) is only available to self-employed persons while the self-directed IRA is available to everyone who has earned income or who has funds in an existing retirement account that can be rolled over to an IRA.
Based on the differences outlined above, a solo 401(k) is generally a better option for someone who is self-employed and still trying to maximize contributions as the solo 401(k) has much higher contribution amounts. On the other hand, a self-directed IRA is a better option for someone who has already saved for retirement and who has enough funds in their retirement accounts that can be rolled over and invested via a self-directed IRA as the self-directed IRA is easier to and cheaper to establish.
Another major consideration in deciding between a solo 401(k) and self-directed IRA is whether there will be debt on real estate investments. If there is debt and if the account owner is self-employed, they are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.
Choosing between a self-directed IRA and a solo 401(k) is a critical decision when you start self-directing your retirement. Make sure you consider all of the differences before you establish your new account.
As 2015 comes to an end, it is critical that Solo 401(k) owners make year-end retirement plans. There are three important deadlines you must know if you have a solo 401(k) or if you plan to set one up still in 2015. A solo 401(k) is a retirement plan for small business owners or self-employed persons who have no other full time employees other than owners and spouses. It’s a great plan that can be self directed into real estate, LLCs, or other alternative investments, and that allows the owner to contribute up to $53,000 per year (far faster than any IRA).
New Solo 401(k) Set-Up Deadline is 12/31/15
First, in order to make 2015 contributions the solo 401(k) must be adopted by your business by December 31, 2015. If you haven’t already adopted a Solo 401(k) plan, you should be starting right now so that documents can be completed and filed in time. If the 401(k) is established on January 1, 2016, or later you cannot make 2015 contributions.
2015 Contributions Can Be Made in 2016
Second, both employee and employer contributions can be made up to the company’s tax return deadline INCLUDING extensions. If you have a sole proprietorship (e.g. single member LLC or schedule C income) or partnership then the tax return deadline is April 15, 2016. If you have an s-corporation or c-corporation, then the tax return deadline is March 15, 2016. Both of these deadlines may be extended 6 months by filing an extension and the date to make 2015 contributions will also be extended. This a huge benefit for those that want to make 2015 contributions but who won’t have funds until later in the year to do so.
W-2’s Force You to Plan Now
Third, while employee and employer contributions may be extended until the company tax return deadline you will typically need to file a W-2 for your wages (e.g. an s-corporation) by January 31, 2016. The W-2 will include your wage income and any deduction for employee retirement plan contributions will be reduced on the W-2 in box 12. As a result, you should make your employee contributions (up to $18,000 for 2015) by January 31, 2016 or you should at least determine the amount you plan to contribute so that you can file an accurate W-2 by January 31, 2016. If you don’t have all or a portion of the funds you plan to contribute available by the time your W-2 is due, you can set the amount you plan to contribute to the 401(k) as an employee contribution and will then need to make said contribution by the tax return deadline (including extensions).
Now let’s bring this all together and take an example to outline how this may work. Let’s take Sally who is a real estate professional and who owns an s-corporation. She is the only owner and only employee and has a solo 401(k) established in 2015. She has $120,000 in net income for the year and will have taken $50,000 of that in wage income that will go on her W-2 for the year. That will leave $70,000 of profit that is taxable to her and that will come through to her personally via a K-1 from the business. Sally has not yet made any 2015 401(k) contributions but plans to do so in order to reduce her taxable income for the year and to build a nest-egg for retirement. If she decided to max-out her 2015 Solo 401(k) contributions, it would look like this.
Employee Contributions – The 2015 maximum employee contribution is $18,000. This is dollar for dollar on wages so you can contribute $18,000 as long as you have made $18,000. Since Sally has $50,000 in wages from her s-corp, she can easily make an $18,000 employee contribution. Let’s say that Sally doesn’t have the $18,000 to contribute but will have it available by the tax return deadline (including extensions). What Sally will need to do is she will let her accountant or payroll company know what she plans to contribute as an employee contribution so that they can properly report the contributions on her payroll and W-2 reporting. By making an $18,000 employee contribution, Sally has reduced her taxable income on her W-2 from $50,000 to $32,000. At even a 20% tax bracket for federal taxes and a 5% tax bracket for state taxes that comes to a tax savings of $4,500.
Employer Contributions – The 2015 maximum employer contribution is 25% of wage compensation for Sally. Since Sally has taken a W-2 wage of $50,000, the company may make an employer contribution of $12,500 (25% of $50,000). This contribution is an expense to the company and is included as employee benefit expense on the s-corporations tax return (form 1120S). In the stated example, Sally would’ve had $70,000 in net profit/income from the company before making the solo 401(k) contribution. After making the employer matching contribution of $12,500 in this example, Sally would then only receive a K-1 and net income/profit from the s-corporation of $57,500. Again, if she were in a 20% federal and a 5% state tax bracket that would create a tax savings of $3,125. This employer contribution would need to be made by March 15, 2016 (the company return deadline) or by September 15, 2016 if the company were to file an extension.
In the end, Sally would have contributed and saved $30,500 for retirement ($18,000 employee contribution, $12,500 employer contribution). And finally, she would have saved $7,625 in federal and state taxes. That’s a win-win.
Keep in mind, you need to start making plans now and you want to begin coordinating with your account or payroll company as your yearly wage information and W-2 are critical in determining what you can contribute to your Solo 401(k).
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Tom W. Anderson
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"Mat's books is a great reference guide for self-directed IRA investing – Best I’ve seen in 30 years of being in the business."
CEO / Polycomp Trust Company
"The Self Directed IRA Handbook by attorney Mat Sorensen is the most comprehensive book ever written about one of the best investment and retirement savings tools ever created: the Self-Directed IRA."
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Mat’s book is the most practical and comprehensive self directed IRA guide in our industry. Reading this handbook should be the first step for any alternative asset investor, investment sponsor, or trusted advisor that seeks to become informed about how to maximize the value of IRAs.