Case Study Profile

Business Type:

Insurance Broker

Business Entity:  

Subchapter "C" Corporation

Owner's Income: 

$150,000 earned income reportable on W-2 prior to bonus at year end

Projected Profit: 

$250,000 prior to plan contribution

Owner's Age:

45

Marital Status:  

Single

Employees:   

None

Plan Objective:  

Maximize tax deductible contribution to provide maximum retirement benefit

Comments:

This individual chose the Subchapter "C" entity form to permit 100% deduction of medical insurance benefits.  However, starting in 2003, health insurance benefits are 100% deductible for shareholder/employees in a Subchapter "S" Corporation and individuals who file taxes as a self-employed individual so the broker changes his entity type from a C to an S corporation and takes the minimum W-2 compensation ($196,000) he needs to maximize his contribution to the SEP and the defined benefit pension plan.

$49,000 with the SEP or Mini(k) but...

The contribution comparison provided above indicates that the Mini(k) offers no advantage over the SEP.  In this instance, the SEP appears to permit the physician to contribute the law's maximum deductible contribution absent the requirement for formal plan documents, governmental reporting and disclosure and the additional cost for professional services typically associated with these requirements. 

However, since the Mini(k) is a Profit Sharing Plan with a 401(k) feature, it can be combined with a Defined Benefit Pension Plan (DB).  As shown below, the combined Defined Benefit and Mini(k) Plans provides the physician with a higher deductible contribution than the SEP.

Mini(k) provides $155,300 more than the SEP in 2011!

The $155,300 differential increases as the 401(k) limit increases since the Mini(k) is a Profit Sharing Plan with a 401(k) feature.  The differential also increases if the maximum defined benefit pension limit increases as it did in 2011 to $195,000 up from $185,000 in 2008 and/or the maximum compensation limit increases as it did in 2011 to $245,000 up from $230,000 in 2008.

Learn more about increased savings provided by Roth 401(k).

What's the catch?  Just one, in reality the Mini(k)Plan is a Profit Sharing Plan with a 401(k) feature.  This means that the Mini(k) is a qualified retirement plan subject to numerous government compliance requirements.  If you don't comply with these requirements, you can lose the benefits gained by choosing this plan type over a SEP or a SIMPLE.  Here's a chart that illustrates just some of the compliance requirements and features for these different plan types.

Compliance Requirements and Plan Features

SEP SIMPLE Mini(k)Plan

Formal Plan Document

No

No

Yes

Trust Reconciliation

No

No, for SIMPLE IRA

Yes, for SIMPLE 401(k)

Yes

Annual Filing

No

No, for SIMPLE IRA

Yes, for SIMPLE 401(k)

Yes*

Rollovers from other Plans and IRAs 

Yes

Another SIMPLE only

Yes

Loans Permitted

No

No

Yes

Advantage to add Spouse

No

Yes

Yes

Updates Required by Law

No

No

Yes

Establish New Plan By

Due date of

return or any extension

October 1 unless

new employer

December 31

Must fund Employee Contribution by

Not

 Applicable

Corporation: Earliest date employer can transmit contributions.

Sole Prop/Partner: by due date or extension.

Corporation: Earliest date employer can transmit contributions.

Sole Prop/Partner: by due date or extension.

Must fund Employer Contribution by

Due date of

return or any extension

Corporation: by due date of return or extension.

Sole Prop/Partner: by due date or extension.

Corporation: by due date of return or extension.

Sole Prop/Partner: by due date or extension

*Recommended but not required until assets exceed $250,000

This chart illustrates basic requirements only.  All plans shown may be selected for audit by the government; all require timely and accurate completion of forms and other related documents when established and ongoing.  Chart is intended as a resource only; consult a professional before implementing any plan.

View comprehensive chart for these plan types: "Compliance Requirements and Limits"

View comprehensive chart for these plan types: "Available Benefits and Features"

Closing Comments

A SEP or SIMPLE plan is traditionally the appropriate plan type for an independent contractor (self-employed individual).  These plan types do not require formal plan documents or governmental reporting and disclosure and the additional cost for professional services typically associated with these requirements.  Both the Min(k)  (Profit Sharing Plan with a 401(k) feature) and the Defined Benefit Pension Plans are qualified retirement plans requiring formal plan documents and governmental reporting and disclosure. 

The maximum deductible contribution to a SEP is the lesser of 25% of compensation (earned income) or $49,000.  As shown in the chart above, this means that the physician with at least $196,000 of W-2 earned income can contribute the law's maximum deductible contribution to either the SEP or the Min(k).

However, the combined Mini(k) and Defined Benefit Pension Plan provides the insurance broker with a $155,300 higher deductible plan contribution and a significant increase in benefits at retirement.  The $155,300 differential shown above reflects the $16,500 401(k) limit for 2011 and the $195,000 maximum defined benefit limit for 2011 (up from $185,000 in 2008).

Bottom Line:  In the example above, if the insurance broker desires a deductible plan contribution of $49,000 or less, the SEP is the preferred plan since it does not require formal plan documents, and governmental reporting and disclosure.  However, be mindful that the SEP typically requires the inclusion of part-time employees (if they earned $550 or more in any 3 out of the prior 5 years).  Further, the SEP does not facilitate the inclusion of a spouse working for the business.

If the physician desires the maximum deductible contribution permitted by law, the combined Mini(k) and Defined Benefit Pension Plans are the preferred plans.  The associated cost to establish and maintain the combined Mini(k) and Defined Benefit Pension Plans is justified based on the additional tax savings and the dramatic increase in benefits at retirement.

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We intend the information provided as a general resource, not as formal investment or retirement planning advice or counsel. If you consider any actions discussed in this analysis, we suggest that you consult a qualified planning professional. ERISA Expertise LLC does not warrant and is not responsible for any errors and omissions from this information. Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.