Q&A with a CPA: Self-Employed Retirement Accounts
Q: What are some ways to invest my money (retirement/401k etc) that will be a tax write off for next year’s taxes? – Nicolle O., Nicolle Osequeda Counseling
KCL, CPA: This is a great question because there are actually a couple things to clarify in the answer.
First, let’s talk about retirement accounts and the tax write-off aspect. Most types of retirement savings accounts offer tax breaks up front – you have the ability to deduct the amount of money you put into the account each year from your income to save on taxes. Over the years, as the money grows through earning interest, dividends and capital gains, that is also tax-free. You only pay taxes on that money when you begin to withdraw it, which can happen as early as age 59 ½, when the option to withdraw penalty-free is available, or at age 70 ½ when the law requires you to take a minimum amount out each year (called your Required Minimum Distribution or “RMD”).
But of course, like most things, there are several different options with their own caveats and exceptions. There are a few different factors to consider before you decide which type of account to utilize. For example, each type of retirement account has limits on how much you can contribute. Traditional IRA’s and Roth IRA’s have the lowest limits – you can only put up to $5,500 into these accounts each year ($6,500 if you’re over age 50). If you have a job with a 401k plan, then you can put up to $17,500 (or $18,000 in 2015) per year. For more on 401k’s, IRA’s and Roth IRA’s, check out my previous article.
If you’re self-employed, like Nicolle, then you have a couple more options, largely dependent on whether or not you have employees and how many employees you have. If your company is just you, and you have no plans to ever hire an employee, then the SEP-IRA would probably make the most sense. The account type’s aspects are similar to a traditional IRA, except that you can contribute more to the plan each year. (twenty-five percent of your earnings up to $52,000/$53,000 in 2015) Another option would be a SIMPLE plan, which is described by the IRS as, “ideally suited as a start-up retirement savings plan for small employers not currently sponsoring a retirement plan.” The next step up from a SIMPLE plan would be to start a 401k plan for employees.
For any of these accounts, you can deduct the money you put into them from your income in the year you deposit the money – except for Roth IRAs. So to answer Nicolle’s question, since you’re self-employed and you don’t plan to hire employees, a SEP-IRA is probably your best bet. You can open an account like this with any financial institution that offers investment accounts. If you’re a DIY person, Vanguard and Fidelity are great low-cost options. If you have employees, then it gets more complicated and you’ll want to consult with a financial adviser who specializes in qualified retirement plans. But any employer-sponsored retirement plan will offer you a tax write-off in the year you contribute. For contributions into IRA’s made between January 1st and April 15th, you can elect to treat those as prior year contributions or current year. That will depend on your tax situation and your CPA can help you decide.
Once you’ve decided on the type of account you should open, then next question is what assets to purchase with your contributions (or to put it another way, how to invest the funds). You’ll be depositing cash into the account, but if you want the money to grow faster than inflation, you’ll want to look at buying stocks, bonds, mutual funds or index funds. Deciding the best way to invest your money once it’s in your retirement account is a separate column – stay tuned for that one next week!