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March 18th, 2011 posted by Amanda Han CPA (Taxloopholes.com Tax Strategist)

Did you know that one of the simplest and most powerful tools that you as a business owner can utilize to maximize your tax savings is retirement planning?

Examples of common retirement accounts for small business owners may include SEP IRAs, Solo 401Ks, and Defined Contribution Plans to name just a few.

The 2 Top Reasons to Use Retirement Planning as a tax strategy tool:

  1. Retirement accounts are great vehicles that you can use to minimize your current taxes with contributions, and
  2. Money in the retirement account allows you to supercharge your investing power with Tax Deferred (or Tax Free) investments

As a business owner, you can actually be in TOTAL CONTROL of your retirement money in terms of what you want to invest in. For retirement accounts that are set-up as self-directed accounts, you as the investor may have the ability to invest your money outside of the traditional stocks, bonds, and mutual funds. For the most part, self-directed accounts can invest in just about anything you can think of including real estate, precious metals, farms, or your cousin’s start-up company!

So with all the choices you have, just which type of retirement account is best for your business? There are several key items to take into consideration when making this determination:

1) How many employees do you have?

2) What are your goals for the business?

3) What kind of vesting requirements do you want to have?

3) Would you like to be able to borrow from the plan?

4) How much would you like to contribute towards the plan?

One of my favorite retirement savings vehicles is the Solo 401(K) plan.

The Solo 401(k), commonly referred to as Solo K, is a retirement plan designed for the small business owner. How small is small you may be wondering? You qualify if you are a self employed individual with no full time employees other than a spouse. One thing to note is that employing independent contractors in your business does not disqualify you from establishing a Solo 401k. Sole proprietors, independent contractors, C corporations, S corporations, partnerships and LLCs can qualify for this plan if the above requirement is met.

With all the different types of retirement plans available, let’s go over the Top 6 Reasons to Consider the Solo 401(k) for Your Small Business:

REDIRECT MORE TAX DOLLARS INTO YOUR RETIREMENT ACCOUNT: One of the benefits of a Solo K plan is in the large annual contribution limits allowed. Businesses with a spouse on the payroll can also contribute to the Solo 401k. Provided the business owner and spouse have sufficient income from the business, taxpayers may be able to contribute up to $49,000 each ($54,500 each if both are age 50+) in 2011. As you can see, a Solo K Plan may allow the taxpayers to contribute a total of $98,000 or $109,000 (if both age 50+) during the year. This is significantly higher in dollar amount as compared with an IRA or a Roth IRA.

TAX DEFERRED AND TAX FREE INVESTING ALL-IN-ONE: Instead of having a traditional and a separate Roth IRA, the Solo K plans allow certain taxpayers to make pre-tax and after-tax contributions to the same account. Unlike the typical pre-tax retirement plans, taxpayers may now be allowed to invest through Roth Solo K’s as well. The Roth Solo K’s are very similar to the Roth IRAs that you may be familiar with in that contributions are made to the account after-tax and the earnings grow tax-free forever!

So how do you know whether you should contribute to your regular or Roth Solo K? Well, the answer to this question will differ from person to person.

Some factors to consider are;
1) How many years do you have until retirement?
2) What is your current tax rate?
3) What is your expected tax rate at retirement?
4) What type of investments will you be making within the retirement account?
5) What other types of assets and investments do you have?

In short, the benefit of investing with after-tax dollars lies in the number of years until retirement and the effect of its compounding growth. If planned properly, this could be an extremely beneficial way for you to invest TAX FREE FOREVER.

NO INCOME LIMITATION FOR ROTH CONTRIBUTIONS: Most of you may be familiar with the current income limitations that are in place to disallow higher income taxpayers to make contributions to Roth IRAs. The amount at which Roth IRA contributions phase-out completely for the 2011 year is $122,000 and $179,000 for single and married joint taxpayers respectively. Another great benefit of the Roth Solo K plan is that this plan eliminates the income ceiling. Essentially, the Roth Solo K allows businesses owners, regardless of their income level, to contribute and participate in the Roth Solo K contributions!

MORE INVESTMENT OPPORTUNITIES: For those of you who have self-directed IRAs, you may be familiar with its restriction from investing funds in S Corporations. Fortunately for a loophole in the tax law, you CAN use your Solo K money to invest in S Corporations. In addition to the traditionally off-limits S Corporation, Solo K funds can also invest in most other types of legal entities such as LLCs, Partnerships, and C Corporations. So in addition to the seemingly endless types of investments offered by the ability to self-direct, Solo K plans also allow for an almost limitless opportunity to invest in most types of legal entities.

ABILITY TO LEVERAGE YOUR MONEY: For those of you who are real estate investors, you undoubtedly have heard of the term Unrelated Debt Financed Income Tax (UDFI). Essentially, this is a tax imposed on certain retirement funds investing in assets with related debt financing. One of the biggest benefits of investing in real estate with your Solo K plan is that this plan actually allows you to invest in leveraged real estate without the taxes potentially associated with UDFI!

With leverage being one of the preferred ways to invest, real estate investors need to tap into the benefits of this loophole. To take it a step further, Solo K funds are exempt not only from UDFI taxes but also exempt from UBTI taxes (Unrelated Business Income Tax) as well. This is a great benefit that the Solo K plans have above most other types of retirement plans.

ACCESS TO FUNDS TAX & PENALTY FREE: One of the greatest loopholes allowed by the Treasury Department relates to the ability for a taxpayer to borrow funds from his or her own 401K accounts. Unlike the traditional IRA, Solo K plans also allow for that flexibility. Taxpayers are able to tap into their Solo K funds for ANY reason tax and penalty free. Participants can borrow up to the lesser of $50,000 or 50% of the account balance. This is a great benefit of having a Solo K plan because it can serve as a source of liquidity for your business, investments, and your emergency fund.

As we talked about before, retirement investing is one of the most powerful tax saving tools that you can utilize as a business owner. If you think the Solo K may be the best retirement plan for your business but already have another type of plan established, consider the opportunity to rollover those amounts into a Solo K plan. Most types of retirement accounts can be converted into Solo K funds.

Remember, retirement investing is an extremely powerful tool that allows you to pay towards your retirement rather than to the IRS. As a business owner, retirement planning is an essential component to your tax savings plan so make sure you speak to your tax advisor to take advantage of this powerful tool to significantly reduce your tax bill!