Case study - financial planning options for a landscaping business owner.

For a 23-year-old landscaping business owner (LLC) who is considering S-Corp status for tax purposes, wants to set up a flexible retirement plan with tax-free distributions (similar to a Roth), and has no full-time employees (but may hire in the future), here's a suggested retirement plan approach:

1. Solo 401(k) with a Roth Option

A Solo 401(k) (also known as an Individual 401(k)) could be an excellent option as it allows for high contribution limits, flexibility, and the option for Roth contributions. Here are key features:

Tax-free distributions: Since the client prefers to pay taxes now and avoid taxes during retirement, setting up a Roth Solo 401(k) would allow them to contribute post-tax dollars now, and qualified distributions will be tax-free in retirement.

Employer contributions: As the business owner, they can contribute both as the employee and the employer. This allows for significant contributions when the business is doing well and flexibility to reduce contributions during lean times.Employee (Roth) contribution: Up to $22,500 (2024 limits), or $30,000 if 50 or older.Employer (traditional pre-tax) contribution: Up to 25% of net business income, with a total limit of $66,000 (or $73,500 if 50+).

Flexibility: If there are lean years, the contributions can be reduced or skipped altogether, allowing for maximum flexibility.

No employees: Solo 401(k) plans are ideal for business owners with no full-time employees (only subcontractors or part-time workers). If full-time employees are hired in the future, the plan can be modified to accommodate their participation.

2. SEP IRA

A SEP IRA could be a simpler, lower-maintenance alternative that offers similar flexibility for contributions but without the Roth option. It allows the business owner to make contributions up to 25% of net earnings from self-employment (capped at $66,000 for 2024). However, this would not meet the client’s preference for tax-free distributions since SEP contributions are pre-tax.

Flexibility: Contributions are not required every year, so the business owner can skip or reduce contributions during lean years.

Future employees: If full-time employees are hired, they must also receive employer contributions at the same percentage as the owner’s contributions, which could increase costs.

3. Backdoor Roth IRA

In addition to either a Solo 401(k) or SEP IRA, the client could also contribute to a Backdoor Roth IRA, which allows for tax-free distributions during retirement.

Annual contribution limit: $6,500 in 2024 (or $7,500 if age 50+).

No income limits: Since their income may grow over time, using the backdoor Roth strategy bypasses the Roth IRA income limits.

This can be a good supplemental savings vehicle to their main retirement account, like the Solo 401(k).

4. S-Corp Considerations

If the client elects S-Corp status, they can save on self-employment taxes, especially by paying themselves a reasonable salary and taking distributions. Here’s how that plays into the retirement strategy:

The employee deferral to a Solo 401(k) (Roth or Traditional) would come from their salary (W-2 wages), while the employer contribution can be up to 25% of salary.

By keeping the salary reasonable but not too low, they can balance payroll taxes with maximizing contributions to the Solo 401(k).

Steps to Implement the Plan:

1. Set up a Solo 401(k) with a Roth Option: This can be done through many financial institutions. Since the client is young and prefers Roth-type benefits, they should focus on making employee Roth contributions.
2. Contribute to a Roth IRA (Backdoor if necessary): Max out Roth IRA contributions for extra tax-free retirement savings.
3. Review SEP IRA (if needed): If they want a simpler option, consider the SEP IRA, but note that it won't offer Roth benefits.
4. Revisit the plan annually: Reassess retirement contributions based on the company's performance, considering both the flexibility offered by the Solo 401(k) and possible future employees.
5. Tax Advisor Consultation: Since the client is considering S-Corp status, consulting a tax advisor would ensure they’re optimizing contributions and avoiding pitfalls related to salary structure and retirement plan contributions.

Summary of Options:

Primary Retirement Plan: Solo 401(k) with Roth option.

Supplementary: Backdoor Roth IRA for additional tax-free growth.

Considerations: Flexibility in contributions, allowing for future full-time employees if hired.