The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Texas is representative of a common inquiry regarding establishing a retirement plan for a business. The advisor asked:
“I have clients who, in addition to being employees for businesses earning 'W-2' income, also earn self-employment income on the side. Could they establish their own retirement plans based on their self-employment income?”
Highlights of Discussion
• Yes, self-employed individuals (business owners in their own right) have many of the same options to save for retirement on a tax-favored basis as individuals participating in workplace retirement plans as employees. Self-employed individuals also have the ability to set up retirement plans.
• As long as your clients have net earnings from self-employment, they can have a tax-qualified retirement plan such as a simplified employee pension (SEP) plan, savings incentive match plan for employees (SIMPLE) IRA plan, 401(k) plan, defined contribution or defined benefit plan — in addition to participating in a workplace retirement plan with an unrelated employer (i.e., related employers pursuant to the controlled group rules of IRC. Secs. 414(b), (c) or affiliated service group rules of IRC Sec. 414(m)).
Self-employed individuals must keep in mind these key points regarding retirement plan contribution limits:
• Generally, an individual has one salary deferral limit under Section 402(g) of the Internal Revenue Code (IRC) — regardless of the number of plans in which he or she participates. (There is an exception to this rule for participants in 457(b) plans.) A 401(k) or salary deferral (SARSEP) plan participant must limit his salary deferrals and designated Roth contributions to $17,500 for 2013 or $23,000 if he or she is age 50 or older. A SIMPLE IRA plan participant must limit his or her salary deferrals to $12,000 for 2013 or $14,500 if he or she is age 50 or older.
• Generally, if a self-employed individual’s business is unrelated to the business for which he or she works as a W-2 employee, then contributions between the two plans are not combined when applying the IRC Sec. 415 limit, which restricts the total amount of employee and employer contributions and forfeitures (i.e., “annual additions”) a person can receive annually. Pursuant to IRC Sec. 415, a defined contribution plan participant must limit his or her annual additions to a plan of a distinct employer to $51,000 for 2013, or $56,500 if he or she is age 50 or older. Consequently, if a self-employed individual’s business is unrelated to the business for which he works as a W-2 employee, then he or she has two separate IRC Sec. 415 limits.
Conclusion
When individuals with net earnings from self-employment are working with their tax advisors, they should consider the additional opportunities they may have to maximize their retirement contributions through a tax-favored retirement plan. Financial advisors with knowledge of retirement plans can be a valuable resource for such entrepreneurs.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2013 Columbia Management Investment Advisers, LLC. Used with permission.
