The ABCs of IRAs for the self-employed
If you are among the thousands of residential building contractors struggling to find skilled workers, it may be time to review your employee retirement plan — in the unlikely event that you even have one.
In 2016, 77.9 percent of residential building construction companies (2012 NAICS Code 2361) and 79.6 percent of specialty trade contractors (2012 NAICS Code 238) had no employees, according to U.S. Census estimates. That percentage climbed to 85.4 percent for building finishing contractors, (2012 NAICS Code 2383), including drywallers, painters, carpenters and flooring installers.
If you are among these companies, you rely on other independent contractors rather than employees to perform much of the work you can’t do yourself. And it continues to get more difficult or expensive to secure such help.
Turnover in the construction industry is already about twice the national average for all industries, and companies will need to hire 1.5 million additional workers over the next decade to keep up with growth and fill positions vacated by retiring baby boomers, noted JP Griffin Group, an employee benefits consultancy.
“Salaries and benefits that fail to meet the needs of employees are, by far, the most cited reasons workers leave employment within the construction industry,” the company noted in its 2016 report entitled “Employee Benefit Considerations for the Construction Industry.” The report went on to say that 401(k) retirement plans offer one of the best ways to improve employee loyalty.
Whether or not you plan to hire employees, here is a quick summary of Internal Revenue Service information about the three IRAs for the self-employed or sole proprietors of small construction businesses.
One-participant 401(k)
Among the IRAs for the self-employed , these plans are also referred to as “Solo 401(k)s” or “Solo IRAs” because they are designed for business owners with no employees other than themselves and their spouses. Because it allows an owner to contribute as both an employee and the employer, the Solo RIA provides self-employed owners the greatest opportunity to shelter their income.
In 2018, for example, an owner could contribute all the earned income reported on his or her Schedule C up to $18,500 ($24,500 if he or she is over age 50) as an employee and up to
The downside of Solo IRAs is that owners are generally required to file annual reports with the IRS. On the other hand, because Solo IRAs do not cover non-spousal employees, they do not have to undergo an IRS discrimination test. Also, some owners with Solo IRAs that have less than $250,000 in assets may be exempt from filing annual reports.
Owners can also include provisions in Solo IRAs that allow them to borrow against their savings. IRS rules permit owners to borrow the lesser of 50 percent of their vested account balances or $50,000 at market interest rates. Such loans must be repaid within five years in substantially equal payments at least quarterly.
SEP 401(k)
The Simplified Employee Pension (SEP) plan is designed for small business owners with few employees who want an IRA option with no mandatory annual contributions. This makes the plans well suited to cyclical businesses with choppy cash flow, such as construction firms, because owners can choose to contribute more in good years and less or nothing in lean years.
Employers can contribute the lesser of 25 percent of an employee’s salary, or $55,000 a year, but must contribute the same percentage of salary to all eligible employees’ accounts. The plans do not allow employee contributions.
SEP plans do not have the start-up and operating costs of traditional IRAs, nor do they require owners to file annual reports with the IRS. Owners may not borrow against their account balances.
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is a good start-up plan for small employers who want to allow employees to make contributions. These IRAs for the self-employed are easier and less expensive to set up than Solo IRAs plans and are exempt from discrimination testing, but they can’t be borrowed from and they shelter substantially less employer income. They are generally best suited to companies with 100 or fewer employees.
The plans allow employers to contribute up to $12,500 per year of their own income, or $15,500 for those over 50. While that’s substantially below the Solo IRA, it’s more than double the $5,500 employees can contribute to traditional individual retirement accounts each year.
Employers must follow one of two approaches in terms of making employer contributions to employees’ accounts:
- Match each employee’s contribution on a dollar-for-dollar basis, up to three percent of his or her salary.
- Make nonelective contributions of two percent of each employee’s salary to each employee’s plan, whether he or she chooses to contribute to the plan.
A more complete overview of IRS rules governing self-employed plans, as well as instructions and compliance forms, are available at “Retirement Plans for Self-Employed People.” As you read through the material, be sure to check definitions of IRS retirement terms. Also, be aware that the laws governing retirement plan requirements are complex and change frequently. Business owners, particularly those with more than one business, are urged to consult their accountants or other qualified professionals when creating retirement plans.
