What are the best retirement accounts for realtors? Well, 2021 was one of the best years on record for realtors. With home prices up close to 30% across the country, the residential real estate market had an incredible profitable year. With higher earnings comes the need for better tax and retirement planning. Thankfully, there are several great retirement planning options for realtors who had a strong 2021 and are looking to reduce their taxable income.
A stirring majority of realtors are self-employed. There are many different ways a realtor can be self-employed. They can be a sole proprietor. Alternatively, a realtor can establish an entity, such as an LLC, C or S corporation. The great news is that it is now better than ever to be self-employed. Not only do you have the ability to control your work/life balance, obtain health insurance via Obamacare, but also have the opportunity to supercharge your retirement savings.
Employer 401(k) Plans
Many employers offer their employees access to an employer 401(k) plan. For 2022, the maximum one can contribute as an employee deferral to a 401(k) plan is $20,500, or $27000 if over the age of 50. In addition, some employer 401(k) plans offer a 3%-5% safe harbor matching contribution based on the plan participants salary. The 2022 maximum employee deferral contribution rules provide plan participants with reasonable opportunities to save for retirement. However, today, being self-employed offers you even greater retirement savings opportunities. Below is a survey of the most popular retirement plans for the self-employed.
The SEP IRA
A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) has traditionally been the most popular retirement plan for the self-employed and small business owner A SEP IRA is a pure profit sharing plan that allows the employer to male up to a 25% (20% in the case of a sole proprietorship of single member LLC) profit sharing contribution to all eligible employees up to a maximum of $61,000 for 2022 or $58,000 for 2021. A SEP IRA does not include a catch-up contribution option for those over the age of 50. Also, a SEP IRA is a pure profit sharing plan that does not include any employee deferrals. In addition, all SEP IRA contributions must be made in pretax.
The Solo 401(k)
The Solo 401(k) plan has surpassed the SEP IRA as the most popular retirement plan for the self-employed. A Solo 401(k) plan is an IRS approved retirement plan, which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. A Solo 401(k) plan is basically a regular 401(k) plan covering only one employee. The most popular feature of the Solo 401(k) plan is the ability to make high annual contributions.
In 2022, a Solo 401(k) plan participant under the age of 50 can make a maximum annual employee deferral contribution in the amount of $20,500 ($19,500 for 2021). That amount can be made in pretax, after-tax or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $61,000, an increase of $3,000 from 2021.
For plan participants over the age of 50, an individual can make a maximum annual employee deferral contribution in the amount of $27,000. That amount can be made in pretax, after tax, or Roth. On the profit-sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) annual profit-sharing contribution based on the amount of the net Schedule C amount or W-2, as applicable, up to a combined maximum, including the employee deferral, of $67,500, an increase of $3,000 from 2021.
Related: Solo 401(k) or SEP IRA for Real Estate Investments
SEP IRA vs. Solo 401(k)
The primary reason the Solo 401(k) plan has surpassed the SEP IRA as the most popular retirement plan for the self-employed realtor is the ability to supercharge your annual plan contributions. For example, assume a 52-year sole proprietor realtor earned $100,000 in commissions in 2022. If the sole proprietor had a SEP IRA, the max they would be able to contribute to the plan would be $20,000 (20% of $100,000). Whereas, if the sole proprietor realtor read this blog and set-up a solo 401(k) plan versus a SEP IRA, the realtor would be able to contribute up $40,500 ($20,500 as an employee deferral plus 20% of compensation).
In addition, there are many additional features that make the Solo 401(k) plan a far more attractive retirement plan for the self-employed versus the SEP IRA:
Roth Feature: A Solo 401k plan can be made in pretax or Roth (after-tax) format. Whereas, in the case of a SEP IRA, contributions can only be made in pretax format.
Tax-Free & Penalty Free Loan Option: With a Solo 401(k) Plan, one can borrow up to $50,000 or 50% of your account value what ever is less. The loan can be used for any purpose. A SEP IRA does not offer a loan feature.
Use Non-recourse Leverage and Pay No Tax: With a Solo 401(k) Plan, one can make a real estate investment using a nonrecourse loan (a loan not personally guaranteed by the plan participant) without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax (IRC 514). However, the nonrecourse leverage exception found in IRC 514(c)(9) is only applicable to 401(k) qualified retirement plans and does not apply to IRAs. In other words, using a Self-Directed SEP IRA to make a real estate investment involving nonrecourse financing would trigger the UBTI tax, which is approximately 37%.
Related: Solo 401(k) for Real Estate
Defined Benefit Plan/Cash Balance Plan
For realtors that expect to have consistent annual earnings above $250,000 for the next several years and is looking to out away over $100,000+ a year in a retirement plan, the defined benefit/cash balance plan is your answer.
A cash balance plan, a type of defined benefit pension plan, promises an employee an employer contribution equal to a percent of each year’s earnings and a rate of return on that contribution. Defined benefit plans guarantee a specific benefit at retirement to each eligible employee. In general, defined benefit plan benefits are funded over the working life of the participating employee with annual tax-deductible contributions from the employer. The employee does not make any contributions to the plan. Instead, the employer makes all contributions based on predetermined retirement benefit as outlined in the pension plan document. Based on certain complex calculations by an actuary, a defined benefit/cash balance plan can provide enormous tax benefits and retirement savings to self-employed realtors.
So what is the best retirement account for realtors? For most realtors, the Solo 401(k) plan offers the greatest retirement and tax saving benefits. In addition, a Solo 401(K) plan can also contain a self-directed option allowing one to use their Solo 401(k) plan funds to invest in real estate as well as other alternative assets, such as cryptos, in addition to traditional investments, such as equities. For any realtor who expects to have consistent earnings above $250,000 for several years and wishes to maximize their retirement and tax benefits, the defined benefit/cash balance plan is a great option.