by Amanda O'Brien | Accounting News, News, Newsletter, Retirement, Retirement Savings, Small Business
When it comes to reinvesting in their businesses, small business owners are pros. Buying equipment, hiring employees, and upgrading systems tend to come naturally. But setting money aside for retirement? That often gets put in the “later” category.
Here’s the problem with that approach: there’s no HR team enrolling you in a plan, and there’s no employer match unless you create one yourself. You need to be intentional about building a retirement plan. Here are some strategies to help you build retirement savings while reducing your tax burden.
Start with a 401(k)
A traditional 401(k) is a good starting point because it allows you to contribute a portion of your income before taxes, which lowers your current taxable income. And what makes it particularly enticing for small business owners is the ability to contribute as both the employee and employer. That means higher total contributions compared to other retirement accounts. These plans come with rules, nondiscrimination testing, and reporting requirements, so the setup is a little more complex, but the savings potential makes it worth your time and attention.
Consider a Roth 401(k) for Future Flexibility
A Roth 401(k) works differently than a traditional 401(k). You pay taxes on contributions now, but withdrawals later are tax-free. This can be useful if you expect to earn more in the future, or if you expect taxes to increase.
Many business owners contribute to both a traditional and Roth 401(k) so they’re not relying on one tax outcome.
SEP-IRA Offers Simplicity
The SEP-IRA is simple to open, easy to maintain, and has no annual filing requirements. Business owners can contribute up to 25% of your net income each year, and contributions can be made up until your tax filing deadline. This is helpful if your income varies.
If you have employees, you’ll have to contribute the same percentage for them as you do yourself, so keep this in mind as your team grows. But for solo entrepreneurs and smaller operations, this is a solid choice.
Solo 401(k): Flexibility for Owner-Only Businesses
If you don’t have employees (other than a spouse), the Solo 401(k) is worth looking into. Like a traditional 401(k), you can contribute as both employee and employer. That often allows you to save more compared to a SEP-IRA at similar income levels.
Many plans also offer Roth IRA contributions and loans against the account if you ever need extra funds, offering both flexibility and control.
Think About Combining Strategies
In most cases, using more than one strategy makes the most sense for small business owners, particularly if you have multiple income streams. For example, you might contribute to a 401(k) through your main business and use another plan for side income.
Making multiple strategies work together comes down to knowing how the plans fit together and staying within contribution limits. The rules can get complicated, so working with a professional can help you navigate the best setup, avoid mistakes, and modify your plan as your business grows or your income changes.
by Stephen Reed | Accounting News, News, Retirement Savings, Uncategorized
If you are a freelancer, an independent contractor, or a self-employed individual, you know the perks of working for yourself, but you likely also notice one major drawback: the lack of an employer-sponsored retirement plan like a 401(k). Enter the Solo 401(k) plan. Below we’ll discuss how this plan provides the highest savings potential for solo business owners.
What is a Solo 401(k) Plan?
A solo 401(k) is a tax-advantaged retirement account for self-employed business owners as well as spouses who work for them at least part-time. Individuals who hold a full-time job with access to workplace retirement plans are also permitted to save for retirement in a solo 401(k) with funds earned from a side hustle. A solo 401(k) is also referred to as an individual 401(k), one-participant 401(k) plan, or a self-employed 401(k).
Eligibility Rules and Contribution Limits
There are no age or income restrictions with a 401(k), but you must be a business owner with no employees (apart from a spouse). You may be able to contribute up to $61,000 in 2022 (up from $58,000 in 2021). If you are 50 or older, you can make an additional $6,500 in catch-up contributions.
Solo 401(k) Tax Advantages
With a solo 401(k) you can pick your tax advantage: a traditional 401(k) or a Roth solo 401(K).
- Traditional solo 401(k): Contributions reduce your income in the year they are made, which reduces taxable income. However, distributions in retirement will be taxed as ordinary income. You may owe a 10% penalty in addition to ordinary income taxes on withdrawals you make from a traditional solo 401(k) before age 59 ½.
- Roth solo 401(k): Offers no initial tax break but allows for tax-free distributions in retirement. You may be subject to penalties on withdrawals before age 59 ½.
Generally, if you expect your income to increase in retirement, a Roth solo 401(k) is the better option. If you expect your income to decrease in retirement, go for for the tax break now with a traditional 401(k).
How to Open a Solo 401(k)
If you decide to set up a solo 401(k), you can do so through a financial institution that administers 401(k) plans. Set-up typically follows these steps:
- If you don’t already have one, you need to get an Employer Identification Number (EIN) from the IRS.
- Choose a provider. When reviewing potential plan administrators, look into any applicable fees. You many also want to look for a plan that offers a mix of investment options, including mutual funds, stocks, bonds, ETFs, and CDs.
- Fill out an application and any required documents. The IRS requires an annual report on Form 5500-SF if your 401(k) plan has $250,000 or more in assets at the end of a given year.
- Once you are ready to fund the account, you can roll over money from another retirement account or set up a transfer from a checking or savings accounts.
- Finally, choose your investments and establish contribution levels. Keep in mind that there is no minimum contribution requirement, so you can increase contributions in good years and save less in years when you need more cash reserves for your business.
With high contribution levels, flexible investment options, and fairly easy administration, the solo 401(k) could be a good fit for a one-person business operation, freelancer, or independent contractor, especially if you want the option to save aggressively for the future.
