A SEP (Simplified Employee Pension) is a great retirement tool for individuals that have earned income that doesn’t come on a W-2.
If you are a sole practitioner, you may contribute up to 20% of your Schedule C income for the 2015 tax year, which for many individuals would be more than you could contribute to a 401k at a corporate employer. If you are an owner of a company that has more than one employee a SEP can become a bit more complicated because of required funding of your employees. See the IRS calculation here: IRS Self Employed SEP calculation What is great about the SEP is that it is easy as filling out one tax form and then opening up a new SEP investment account. Dollars invested grow tax deferred and you receive a deduction on your taxes, much like a 401k or deductible IRA.
How much could you save?
If you use TurboTax to do your taxes, enter “SEP account” in the search box; this should pop up as an option to jump to the SEP section under Business Income and Expenses. Enter in a hypothetical SEP investment, and TurboTax will show you how much you could potentially save. If you use a tax preparer, ask them about how a SEP could save you taxes that are due.
A SEP is one of the many plans we use to build personalized investment portfolios for our clients. You may learn about our investment philosophy here.
Please reach out to us if we can help you understand your SEP options, or any retirement options (401ks, IRAs, etc) for that matter.
At least once a week we are approached and asked “what’s the best retirement investment strategy”? Indexing? ETFs? Real Estate? Over the last couple weeks, the question has also evolved to include should I go to cash because of the current market volatility?
First, there is no single “right” investment for each individual or couple. As wealth management advisors, we have a fiduciary obligation to provide tailored personal advice to each client. How do we do this?
There are core tenets that we believe every individual should follow. First, maximize your investments in qualified retirement plans through your employer. If there is an investment match, it is free money – take it! Then, depending on your risk profile (risk taker? conservative? somewhere in between?) and your time horizon (how much time do you have until you need the investment portfolio distributed), structure a portfolio that will help maximize returns within your tolerance for risk. Pay attention to the tax consequences of your decisions, and look to providers that have low portfolio turnover.
For someone close to retirement, generally their risk appetite will be more cautious than someone starting their career. The idea is that someone at the beginning of the career cycle has a 30-year plus investing horizon. The money they invest has 30 years to move up and down, and over the long term potentially grow. Someone within 10 years of retirement, has less of a time horizon, and generally has to be more cautious in how they structure the risk element of their portfolio.
This leads into the “should I go to cash?” discussion when the market gets more volatile and someone is closer to retirement.
A major issue with going to cash is that timing of the market rarely works. An oft-cited study by University of Michigan Professor H. Nejat Seyhun, highlights the issue with great clarity. One key take away from this study states that from 1963 to 1993, only 1.2% of the days the market was open for business accounted for 95% of the market gains.* A second challenge about moving money to cash in a checking account or low interest producing account is that it may not keep up with inflation (meaning the rising costs of goods and services). Most would argue that they would only hold funds in cash for a “short” period of time, but if the period is “short” the issue about market timing becomes front and center.
We believe a more prudent way to invest is to make sure you are invested in the market with broad diversification and the correct risk posture. If you are feeling nervous about the market swings, and your investment fluctuation, maybe you need to be more cautious in your approach so that you stop “worrying” about the market.
* H. Nejat Seyhun, University of Michigan, “Stock Market Extremes and Portfolio Performance,” 1994. Investors cannot invest directly in an index.An exchange-traded fund (ETF) is a security that tracks an index, a commodity or a basket of assets like an index fund, but trades like a stock on an exchange. ETFs are typically registered as unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Some ETFs that invest in commodities, currencies or commodity- or currency-based instruments are not registered as investment companies. Unlike traditional UITs or mutual funds, shares of ETFs typically trade throughout the day on an exchange at prices established by the market. These ETFs are not managed by the issuer. Investors must buy or sell ETF shares in the secondary market with the assistance of a stockbroker. In doing so, the investor will incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling. Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market. Moderate inflation is a common result of economic growth. Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times. Diversification does not guarantee a profit or protect against a loss.
Required Minimum Distributions
We are bombarded by the media about saving for retirement. 401ks, Simplified Employee Pensions (SEPs), Roth IRAs, Traditional IRAs, Rollover IRAs, you name it. If you’ve had the foresight to save for retirement diligently, congratulations!
As you most likely know, you may not keep savings in retirement plans forever. There comes a time when required minimum distributions (RMDs) must occur.
A required minimum distribution is just that – the amount you must withdraw from your tax advantaged savings plan each year. You may withdraw more than the minimum, but you must withdraw the minimum.
With IRAs (excludes Roth IRAs), you must begin your RMD on April 1st of the year following the calendar year you reach 70 1/2.
With 401ks, profit sharing, 403(b)s, or another defined benefit plan, the rules are the same as IRAs except the first distribution must be taken by April 1st of the year following the later of the calendar year you reach 70 1/2 or the calendar year you retire. If you own 5% or more of the company sponsoring the plan there is no extension once you reach age 70 1/2.
The required minimum distribution for any year is the account balance as of the end of the immediately preceding calendar year divided by a distribution period from the IRS’s Uniform Lifetime Table.
Please reach out to us and we can discuss the specifics in detail with you.
* Taxes must be paid upon withdrawal of any deducted contributions plus earnings and on the earnings from your non-deducted contributions. Prior to age 59 1/2, distributions may be taken for certain reasons without incurring a 10% penalty on earnings. None of the information on this page should be considered tax or legal advice. Please consult your legal or tax advisor for more information concerning your individual situation.
529 plans can be a great way for families to save for college. Each state sponsors a plan with one or more providers and some states provide tax deductions for residents participating in the plan. However, there are exceptions. For instance, California does not provide a tax deduction for residents participating in it’s plan. This allows Californians to seek out the best plan from across the country without fear of losing any tax favored treatment.
529s savings plans are not restricted to individuals based on income. 529s offer tax deferred growth much like an employee’s 401k, but unlike a 401k used for retirement, any 529 withdrawal used for qualified education expenses (include tuition, books, room and board) is federal tax free. Maximum contributions vary among states, but our provider allows up to $400,000 to be contributed to a 529 plan per beneficiary, and it is permissible for the account to grow past $400,000.
A common question we hear is “What if my child decides not to go to college?” 529 plan beneficiaries can be changed. If an older sibling decides not to go to college; the plan beneficiary can be changed to a younger child. If that is not an option, there is a 10% federal tax penalty and earnings are subject to income tax.*
Our provider of choice for 529 plans provides enrollment based portfolios, which are time sensitive portfolios targeted towards the freshman year of college for distribution of plan assets.
Andrew has two young children, and is already participating in 529 plans and looks forward to sharing his experience in selection and funding strategies.
* Participation in a 529 College Savings Plan (529 Plan) does not guarantee that contributions and investment return on contributions, if any, will be adequate to cover future tuition and other higher education expenses or that a beneficiary will be admitted to or permitted to continue to attend an institution of higher education. Contributors to the program assume all investment risk, including potential loss of principal and liability for penalties such as those levied for non-educational withdrawals. Depending upon the laws of the home state of the customer or designated beneficiary, favorable state tax treatment or other benefits offered by such home state for investing in 529 college savings plans may be available only if the customer invests in the home state’s 529 college savings plan. Consult with your financial, tax or other adviser to learn more about how state-based benefits (including any limitations) would apply to your specific circumstances. You may also wish to contact your home state or any other 529 college savings plan to learn more about the features, benefits and limitations of that state’s 529 college savings plan. For more complete information, including a description of fees, expenses and risks, see the offering statement or program description.