One of the most common issues for real estate agents is that of retirement planning. As self-employed individuals, or as owners of closely held companies or partnerships, real estate agents generally do not have access to the types of employer-sponsored retirement plans you normally see in the workplace, such as 401(k) or 403(b) plans. Or more correctly, real estate agents do have access to retirement plans, but as their own employer, the path is less clear. This article seeks to show what types of retirement plans are available for real estate agents, specifically as self-employed individuals.
Did you know you can set up a 401(k) for yourself as a self-employed individual? It’s true, and it’s also the option that allows you to set aside the most money into your retirement plan. Also known as a Solo 401(k), Solo-k, Uni-k, or one-participant k, a one-participant 401(k) allows you to take advantage of the fact that you’re both the employer and employee. This arrangement enables you to defer up to $53,000 per year:
- $18,000 in elective deferrals (as the employee)
- Up to 25% of your compensation as defined by the plan (as the employer)
The total amount of your deferral cannot exceed $53,000 per year, according to Internal Revenue Code 415(c), which applies to all defined contribution plans. However, if you’re 50 or older, you also allowed a ‘catch-up’ contribution, which is $6,000 for 2016. The ‘catch-up’ contribution does not count towards the $53,000 limit, but is in addition to it. Also, a solo-401(k) can be a Roth 401(k), so you can contribute after-tax money and receive the proceeds tax-free under Roth rules.
The individual 401(k) is a great plan for individuals, especially since it’s relatively easy to administer, and there are no Employee Retirement Income Security Act (ERISA) testing requirements to ensure fairness to all employees (if you’re the only employee, the assumption is that you’re fair to all employees!). Also, you can take out a loan if needed (although there are probably other options you should look into before you do this).
A key feature of solo 401(k) plans is that they are exempt from rules regarding unrelated debt financed income (UDFI). This means that unlike an individual retirement account (IRA), a 401(k) plan can purchase leveraged real estate and avoid unrelated business income tax (UBIT). This is a very powerful tool if you are a real estate agent who happens to own some property on the side.
However, once you hire an additional employee (other than your spouse), you no longer have a solo 401(k), you just have a 401(k). 401(k) plans are subject to discrimination testing, which requires more administration & paperwork (which you may not want to take on), or require a certain minimum amount of employer contributions in order to become what is known as a safe harbor 401(k). In the event that neither of these seem desirable to you, below are a couple of other options if you plan to hire employees.
Simplified Employee Pension (SEP)
A SEP allows an employer to contribute up to $53,000 or 25% of each employee’s compensation, whichever is less. There are many pros, and a couple of cons, to a SEP.
- Available to any size business
- Minimal paperwork
- No annual filing requirement for the employer
- Low administrative costs
- Flexible annual contributions – good plan if cash flow is an issue, or is cyclical in nature, as it is for real estate agents
- No loans allowed
- No elective deferrals allowed. Unlike a 401(k), the employer makes ALL contributions. Also, since the employer has the option on whether or not to make contributions, employees may find that in financially lean years, zero additions are made to their SEP account.
- Employers must contribute equally to all eligible employees. This is calculated in terms of percentage of income, not in whole dollars. For example, an employer making $200,000 and contributing 10% ($20,000) must contribute 10% for his employee making $50,000, or $5,000 – NOT $20,000.
- Employees are 100% vested immediately, unlike other plans that allow either a graded or cliff vesting schedule.
SIMPLE IRA (Savings Incentive Match Plan for Employees)
For employers who do not want the burden of a 401(k), and who want to enable employee contributions, a SIMPLE IRA may be the way to go. A SIMPLE plan is available to any small business, is easily adopted (by filing Form 5304-SIMPLE, 5305-SIMPLE, a sample SIMPLE IRA plan, or an individually designed plan document. Employees are eligible to contribute, and are always vested (to the chagrin of employers who want to use a graded or cliff vesting schedule for retention purposes). However, the primary limitation is that employers must contribute EITHER:
- A matching contribution up to 3% of compensation (not limited by the annual compensation limit), OR
- 2% nonelective contribution for each eligible employee (up to $265,000 for 2016)
The 2% nonelective contribution is an automatic contribution, regardless of whether the employee contributes to the plan, and is immediately 100% vested, meaning the employee can take that money and transfer it when he or she leaves the company.
An employer who administers a SIMPLE plan cannot offer any other retirement plan.
What about other retirement plans?
It’s worth briefly mentioning some other plans, just to clarify any stray thoughts you may have seen, either in writing or in conversation. However, if you’re looking at starting your own plan, you’re probably not going to expand past the options mentioned above, unless you have designs to run a huge ensemble practice, firm, or company. If that’s the case, you should probably be consulting with a qualified plan administrator to thoroughly discuss your firm’s objectives.
- Profit-sharing: Allows you to decide how much to contribute on an annual basis, up to 25% of compensation (not including contributions for yourself) or $53,000 for 2015 and 2016. Great as an employee retention tool, but can be more complex to administer, and is subject to discrimination testing.
- Money purchase plan: Requires you to contribute a fixed percentage of your income every year, up to 25% of compensation (not including contributions for yourself), according to a formula stated in the plan.
- Defined benefit plan: Traditional pension plan with a stated annual benefit you will receive at retirement, usually based on salary and years of service. Note: It’s rare to see a company offer a traditional pension plan anymore. Even the military, known as the last bastion of defined benefit plans, is scaling back on its pension plan for future servicemembers.
- Keogh plan: Keogh plans used to be a much more preferable savings vehicle. However, since there are many other plans that offer similar contribution limits that are much easier to maintain, Keogh plans have fallen out of favor.
The Bottom Line
For most solo agents, you probably need to look no further than the solo 401(k). It allows the most flexibility, highest contribution limits, and the least administrative burden. However, if flying solo is just step 1 of a multi-phase career path, you might want to have a decent idea of what type of business you’re building, so you can implement a retirement plan that allows you to maximize your retirement savings while giving you the flexibility to bring on and retain quality employees in a competitive manner.