Strategies for Funding Multiple Nest Eggs
With more Americans working for themselves in addition to a full-time job, there’s greater opportunity to invest in tax-advantaged retirement accounts.
Rapid changes in the workforce are affecting the way Americans save for their retirement. Today’s younger workers, commonly referred to as millennials, are more likely than prior generations to have additional income through a side job—e.g., Uber driver, app developer, etc.—or in today’s parlance, a “gig,” in addition to a full-time corporate job. All of which suggest the next generations will follow a more eclectic approach to saving for retirement.
Can workers contribute to more than one retirement plan? It’s a great question, and one I get with more frequency. The short answer is, yes, although there typically are a few hoops to jump through.
Suppose, for example, you have income from freelance consulting work. The opportunity to boost your retirement savings is substantial, but make sure you familiarize yourself with the maze of rules that apply to establishing more than one retirement plan.
Although there are numerous options to help build an extra nest egg, the most common example is an individual enrolled in an employer’s 401(k) who would like to fund a Simplified Employee Pension (SEP) IRA using income derived from a side business. So, let’s explore that scenario.
The first checklist item would be to confirm the business(es) you own has no common control or affiliated relationship. Consult with an experienced tax and or legal professional for assistance in determining whether you satisfy the common control or affiliation standards.
For the purposes of this column, let’s assume that the businesses are not part of a controlled group. So, as long as firms are not affiliated, the contribution limits for, say, a 401(k) and SEP IRA, are independent of each other. Under Section 415(c) of the Internal Revenue Code (IRC), that means you can contribute up to $55,000 per employer in 2018 ($54,000 in 2017). However, salary deferral limits under IRC 402(g) that apply to 401(k) deferrals are per individual. In 2018, the maximum deferral limit, regardless of the number jobs, is $18,500 ($24,500 for age 50 under catch-up provisions).
A SEP is generally the best option for an individual who already has maxed out his or her 401(k), 403(b), or SIMPLE (Savings Incentive Match Plan for Employees) IRA through his or her full-time corporate job. Why? SEP funding would be done solely with employer contributions, for which the limit is the lesser of 25% of eligible compensation, or $55,000.
Imagine being able to fund a SEP IRA (using side-business income) even if you participate in a 401(k) at your day job. In 2018, for example, an individual can save up to $55,000 in a SEP plus $18,500 in a 401(k), and tack on an additional $6,000, including the 401(k) age 50 catch-up. In addition, virtually all individuals are eligible to fund an IRA—another $5,500 ($6,500 for those aged 50 and older).
Don’t forget, though, that SEP contributions not only are discretionary but they also are tax deductible. So, you still have time to establish a SEP for the 2017 tax year! Accounts can be established as late as the business tax filing deadline, plus extension.
Suppose Monica, 48, works for PNQ Inc., deferring last year's (2017) $18,000 contribution into her 401(k) account. Her employer contributes another $36,000 (for a total of $54,000 through a combination of match and profit sharing contributions). Monica also is the sole proprietor of a consulting business. There is no common control between her consulting firm and PNQ Inc. Monica can fund her SEP IRA up to the lesser of 25% of compensation, or $54,000. (See our calculator to determine how much can be contributed to SEP IRA.)
As previously mentioned, Monica continues to be eligible to fund a traditional or Roth IRA, assuming her income qualifies. However, the traditional IRA contribution may not be tax deductible. Also, Monica may be a candidate for the “back-door” Roth.
If you have any questions about this or another retirement topic, please e-mail me at firstname.lastname@example.org.
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Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.
A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.
Backdoor Roth IRA. Since 2010, high-income earners have been eligible to convert traditional IRA assets to Roth IRAs. This is accomplished by making nondeductible (aftertax) contributions to a traditional IRA and converting the assets to a Roth sometime thereafter.
A SIMPLE IRA plan is an IRA-based plan that gives small-business employers a simplified method to make contributions toward their employees’ retirement and their own retirement. Under a SIMPLE IRA plan, employees may choose to make salary reduction contributions and the employer makes matching or nonelective contributions. All contributions are made directly to an individual retirement account (IRA) set up for each employee (a SIMPLE IRA). SIMPLE IRA plans are maintained on a calendar-year basis.
A simplified employee pension plan (SEP IRA) is a retirement plan specifically designed for self-employed people and small-business owners. When establishing a SEP-IRA plan for your business, you and any eligible employees establish your own separate SEP-IRA; employer contributions are then made into each eligible employee’s SEP IRA.
A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an aftertax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.
A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.