Many real estate entrepreneurs don’t realize all the benefits that retirement plans offer to the self-employed. This is often because real estate professionals often see themselves solely investing in real estate and don’t see any need to “set money aside” in a retirement plan. However, the tax benefits are very clear:
- employer contributions are deductible from the employer’s income;
- employee contributions (other than Roth contributions) are not taxed until distributed to the employee; and
- money in the plan grows tax-deferred or tax-free (in the case of a Roth).
Small businesses may choose to offer defined contribution plans or defined benefit plans. Many financial institutions and retirement plan practitioners make available one or more of these retirement plans that have been pre-approved by the IRS. The reality is that there are many different plans available to business owners and each type of plan comes with its own pros and cons.
Defined contribution plans are employer-established plans that do not promise a specific amount of benefit at retirement. Instead, employees or their employer (or both) contribute to employees’ individual accounts under the plan, sometimes at a set rate (such as 5 percent of salary annually). At retirement, an employee receives the accumulated contributions plus earnings (or minus losses) on the invested contributions.
Defined benefit plans, on the other hand, promise a specified benefit at retirement, for example, $1,000 a month. The amount of the benefit is often based on a set percentage of pay multiplied by the number of years the employee worked for the employer offering the plan. Employer contributions must be sufficient to fund promised benefits.
In addition to helping your business, your employees and yourself, it is easy to establish a retirement plan, and there are additional reasons for doing so:
- High contribution limits so you and your employees can set aside large amounts for retirement;
- Funds in retirement plans are normally excluded from bankruptcy;
- “Catch-up” rules that allow employees age 50 and over to set aside additional contributions. The “catch up” amount varies, depending on the type of plan;
- A tax credit for small employers that enables them to claim a credit for part of the ordinary and necessary costs of starting a SEP, SIMPLE, or certain other types of plans. The credit equals 50 percent of the cost to set up and administer the plan, up to a maximum of $500 per year for each of the first 3 years of the plan;
- A tax credit for certain low and moderate income individuals (including self-employed) who make contributions to their plans (“Saver’s Credit”). The amount of the credit is based on the contributions participants make and their credit rate. The maximum contribution eligible for the credit is $2,000. The credit rate can be as low as 10 percent or as high as 50 percent, depending on the participant’s adjusted gross income; and
- A Roth plan that can be added to a 401(k) plan to allow participants to make after-tax contributions into separate accounts, providing an additional way to save for a tax free retirement. Distributions upon death or disability or after age 59 from Roth accounts held for 5 years, including earnings, are generally tax-free.
Real estate professionals must understand that there are several retirement plans available to them. In addition, many of these plans allow the owner to “self-direct” so they can invest in real estate, tax liens, or promissory notes. The owner has the ability to take control of his or her retirement and still invest in real estate.
