17 Dec Retirement Planning for Real Estate Agents
Real estate agents have financial obstacles and opportunities due to the very nature of how they are paid. Uneven cash flow and being self-employed can make saving for retirement difficult. Most realtors don’t have the advantage of a retirement plan sponsored by their employer and without a paycheck tied to an annual salary, making consistent deferrals can be tricky. However, these very same obstacles that can make retirement saving challenging can also give realtors additional options that can be used to their advantage. Two of those options are the Simple Employee Pension (SEP) and the Solo 401(k).
Simplified Employee Pension (SEP)
SEPs are a good option for real estate professionals because they are simple and flexible. A SEP is an IRA type plan, but with much larger annual contribution limits than a traditional IRA. In traditional IRAs the individual contributes to their own account, but with a SEP IRA the business contributes for the employee. Employee contributions are not allowed. For a self-employed person, such as a real estate agent, this isn’t a big distinction, but it can impact a business owner who has employees.
Those who choose to open a SEP for their business can contribute the lesser of 20% of net self-employment income or $56,000 in 2019. If you have employees, you will need to contribute the same percentage of their compensation as you contribute for yourself. This is an important point to consider and can make it difficult for the owner to max out their plan without contributing a large percentage for their employees as well.
The ability to contribute for employees can also be an advantage if you plan on hiring someone soon. From a business planning perspective, it may make sense to install a plan that does allow for you to contribute for your employees. If you find that the SEP isn’t the best fit, you can transition to something different in a year or two after onboarding your new employee(s). With that in mind, a SEP can give you a bit of flexibility when it comes to growing your business. If you already have employees, there may be another option (such as a SIMPLE) that would better suit your needs. A CERTIFIED FINANCIAL PLANNER™ would be able to help you identify the best option for you and your business.
Although many retirement plans provide for additional contributions over age 50, there are no catch-up contributions available with SEPs. Catch-up contributions for those 50 and older that are available in Traditional IRAs, Roth IRAs and 401(k) plans are only available on the employee contribution portion.
Like other retirement plans, the SEP offers some significant tax savings. The amount that your business contributes to the SEP plan account(s) is deductible from the business tax return for that year and is not included in your adjusted gross income. The money that is contributed to the SEP is invested and grows tax-deferred. When you withdraw the funds in retirement you will pay tax on the entire amount at your ordinary income tax amount, presumably at a lower rate.
One of the biggest advantages that a SEP has to offer to realtors is the flexible contributions. Contributions can vary year-to-year just as commissions do. Although it’s a good idea to try to stick to a minimum amount, it is nice to know that if sales decrease you can decrease the amount you save for retirement that year and aren’t bound by a rigid plan. You can even skip contributions entirely in a given year. The opposite is true too, if you have a great year and have available cash you can contribute more, just don’t go over the maximum amount allowed for that year. If you have employees, you can change the contribution percentage annually for them as well.
SEPs are a good option for a self-employed real Estate Agent because they are simple and inexpensive to set up and maintain. There are no annual tax filing documents (such as a form 5500) required. The only paperwork needed to start the plan is the initial plan documents and the forms required by the custodian to open the account(s). You have until your business tax filing date to open a SEP for the prior year.
Another great option for Real Estate Agents is a Solo 401(k) – also known as an Individual 401k. With a Solo 401(k) plan you cannot have any employees except for your spouse. This is a great option for husband and wife teams that don’t have any other employees – you can double the household contributions since each spouse has their own Individual 401(k) account.
A Solo 401(k) allows for employer and employee contributions, which is a major difference when compared to a SEP that only allows for employer contributions. The employee contributions in a Solo 401(k) allow for potentially greater annual contributions at the same income level.
Solo 401(k) plans allow for contributions by both the employee and the employer. Employee deferrals can equal a maximum of $19,000 in 2019. Employer contributions can be up to 20% of net self-employment income. The total annual contribution is limited to $56,000. This is like a SEP, but because of the ability to make employee deferrals in addition to the employer contribution the Solo 401(k) can often be more advantageous.
Let’s look at an example of a realtor who makes $100,000 a year. If they contribute $19,000 in employee deferrals and an additional $20,000 (20%) in employer contributions, the total is $39,000. With a SEP, that same realtor could have contributed a maximum of $20,000. If maximizing contributions is the goal, the Solo 401(k) may be the better option.
Solo 401(k) plans allow for catch up contributions for those 50 or over. This is an advantage over the SEP if you are 50+ and want to contribute as much pre-tax as possible to your retirement. The catch-up contribution amount for 2019 is an additional $6,000. The catch-up contribution must come from the employee deferral portion of your annual contribution but does allow for a greater overall annual contribution. For those who have reached the age of 50 you can contribute a total of $62,000 for 2019 in your Solo 401(k).
Another beneficial feature of the Solo 401(k) is that you can implement a Roth option as well if your goal is to not pay taxes once you retire. A Solo 401(k) with a Roth option works much like a Roth IRA, except you must take Required Minimum Distributions at age 70½ unless you roll the Roth 401(k) over to a Roth IRA. Having some retirement savings in a Roth account adds a layer of flexibility from a tax and an RMD perspective.
Traditional 401(k) plans have a reputation of being expensive to maintain and difficult to set up. However, this is NOT the case with a Solo 401(k). The paperwork is relatively simple and there are no annual filings initially. Once the plan has more than $250,000 in assets, there is a requirement to file Form 5500-SF with the IRS annually – easily accomplished by an accountant.
Should You Open a SEP or Solo 401(k)?
Both plans can offer robust tax deferred savings for retirement. If you have any employees other than your spouse, or you think you might in the very near future, a SEP might be preferable. If you don’t have employees and really want to maximize savings a Solo 401(k) might be the better option. The potential to maximize your tax savings is even higher with a Solo 401(k) if you are 50 or over with catch-up contributions.
The best way to figure out which plan is best for you and your Real Estate business is to talk to a CERTIFIED FINANCIAL PLANNER™. Your CFP® professional can look at your entire financial picture, both personal and business and make recommendations that will help you reach your retirement goals. They can also help with things such as pin pointing your risk tolerance and investment recommendations after you get your new retirement account open. Retirement planning mistakes can be very costly, so it’s important to work with a Financial Planner or a Registered Investment Advisor who puts your best interest before their own.