Retirement Account Primer
As many of you have come to realize, planning and investing for retirement falls squarely on your shoulders. This is particularly true for dentists as fewer and fewer associate positions, with the possible exception of corporate dentistry, have any benefits available to them. This article in intended to identify some retirement vehicles you should consider when paid as 1099 independent contractor(IC) or you have formed a single member/shareholder entity with one employee (you) such as an LLC or S-Corp.
Some of the more common retirement vehicles available to ICs and single member/shareholder entities are as follows:
Solo or Individual 401k
SEP IRA (Simplified Employee Pension Individual Retirement Account)
Traditional IRA
Roth IRA
With the exception of Roth IRA, these are pre-taxed retirement accounts. This benefits you by lowering your adjusted gross income, which lowers your taxable liability, which also lowers your income-driven payment. Establishing and participating in a retirement vehicle also allows you to benefit from tax deferred compound growth.
Solo or Individual 401k
This is listed 1st of a reason – it’s my favorite. This is because of its higher annual contribution limits (up to $54k in 2017), a portion of which could be in a Roth, and elective employee contributions (or salary deferral) of up to $18,000. The remaining $36K ($54k - $18k employee contribution) is an employer contribution (note – you are both the employee and employer). The employer contribution is either 25% of W-2 wages in S-Corp or 20% of net income for ICs for those who are not taxed as an S-Corp.
This retirement vehicle presents a bit more flexibility than an SEP IRA and allows an easier means to contribute a higher amount by virtue of the employee contribution of up to $18k annually. The only minor concern with the Solo 401k is you must establish the retirement plan by end of the tax year when you first establish the plan.
SEP IRA
The SEP IRA is similar to the solo 401k. The significant difference is the employer contributes up to $54k per year. The annual contribution is determined as a percentage of net income. That percentage is 20% of net income. There is no employee contribution which may make it more difficult to reach the annual limit of $54k. To reach the $54,000 annual limit, you would have to generate a net income of about $270,000.
The one advantage, I feel, the SEP IRA has over the solo 401K is that you can established and contribute to it up until April following the close of the previous tax year.
Traditional IRA
A Traditional IRA is probably something you are familiar with. The annual contribution limit is $5,500 on earned income. As with the other retirement vehicles, there is a catch-up provision for those aged 50+. Contributions are made on a pre-taxed basis which lowers your adjusted gross income.
Roth IRA
A Roth IRA is an after-tax vehicle (so it does not lower your adjusted gross income) with annual contribution of up to $5,500. The primary benefit of a Roth IRA is qualifying withdrawals are tax free. The general strategy is to contribute to a Roth during your lowest marginal tax rate years.
Also, there are income limits in order to participate in a Roth - For single tax filers, it's $117,000 modified adjusted gross income and $184,000 modified adjusted gross income for married filing jointly. For those that exceed the income limits, a "backdoor" Roth is available.
Closing
Identifying the various retirement options is one step in the planning process. Selecting an investment firm (custodian) and the underlying investments is the second step. This second step can be overwhelming as there are 100's of investment firms and 1,000's of investment options to consider. This process is made easier with a trusted adviser
(me, maybe?).
I do encourage to establish a retirement strategy early in your careers to benefit from compound growth.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.” Albert Einstein