By Kristi De Rycke, Registered Assistant
Are you or do you know someone who is self-employed? Individuals who are a business of one or have a small company pour a lot of blood, sweat and tears into their business. This is what it takes to get things started, but do you also have your eye on the end game? There are many differences between you and those of us that get a regular paycheck, but one thing remains the same. The longer you wait to put money away for retirement, the more you will have to put aside. Are you aware of the options at your fingertips to save for your future? Let’s break down the 6 options here.
Option 1: The traditional IRA or individual retirement account is a common option and relatively easy to understand. The maximum for 2021 that you can contribute to the IRA is $6,000. If you are 50 or older, you can add an additional $1,000 catch-up contribution. The traditional IRA does have income limits only if you or a spouse are offered a retirement plan through an employer. If you are covered by an employer plan, the maximum that you can make as a single person is $66,000 and as a couple filing jointly is $105,000. You can do a partial contribution unless you make over $76,000 single/$125,000 married filing jointly. If your spouse is covered by an employer plan but you are not, you can contribute as long as you are not over $198,000 for the full contribution and $208,000 for the partial contribution. Check out www.irs.gov for more details. You can decide to automatically contribute a certain amount monthly or in a lump sum when you have more cash flow. If you contribute to a Traditional IRA, your income will be reduced dollar for dollar by that amount. If you make $50,000 and you put $5,000 into a Traditional IRA, your income will look more like $45,000 to Uncle Sam for that calendar year. This money will then grow without paying any taxes on it until you withdraw it. At that time, you will be taxed on it as ordinary income. You can withdraw money out of either of them at 59 ½ without having to pay a penalty. You are required to take out required minimum distributions (RMDs) starting the year you turn 72.
Option 2: The Roth IRA is similar in that it is not linked to an employer. Anyone can contribute to the Roth IRA even if you or your spouse participate in a retirement plan at work as long as you are under the income limits. The 2021 Roth IRA limits for the full $6,000 annually or $7,000 if 50 and older is less than $125,000 for an individual and less than $198,000 for married filing jointly. You are able to do partial contributions as long as you are under $140,000 individual/$208,000 married filing jointly. When you contribute to a Roth IRA you do not reduce your income for taxes in that year. They are post tax meaning that you pay taxes on the money and then contribute to the Roth IRA. You can withdraw money at 59 ½ without any penalty. The Roth IRA allows more flexibility on early withdrawals before this age. The exceptions to the 10% penalty would include using it for medical expenses, health insurance if you have collected unemployment for at 12 weeks, college costs, first home purchase ($10,000 individual/ $20,000 per couple), disability expenses, active duty over 179 days or if your IRA is set up with regular payments in an annuity (1). There are no RMDs for a Roth IRA as you have already paid the taxes. Still confused about the differences between traditional IRAs and Roth IRAs, check out a previous blog "Can You Spot The Difference Between A Traditional IRA & Roth IRA?".
Option 3: The Solo 401(k) also may be a great option for a business owner with no other employees other than a spouse. You are allowed to contribute up to $58,000 and can add $6,500 catch-up contributions if over 50 years of age for 2021. This gets a little confusing as you can contribute as an employee and then as an employer based on profits. You can contribute up to $19,500 as an employee of your own business or $26,000 if at least 50 years of age. The amount you can contribute as the employer of your own business depends on how your business is set up. If you own a corporation, the maximum profit-sharing contribution is 25% of your gross income. If you own a Sole Proprietor/Partnership the maximum profit-sharing contribution is 20% of net income. Some providers also offer the Roth with similar features as the Roth IRA. (2)
Option 4: A SEP-IRA is a simplified employee pension and is good option for a business owner with any number of employees. Only the employer can contribute to this plan. If you have more than 1 employee, you are required to contribute the same percentage of salary for every employee each year. You also must contribute the same amount that you contribute to your own. As an employer, you can put away up to 25% of your income and therefore up to 25% of your employee’s salaries with a maximum of $58,000 for 2021. The amount you choose to contribute can vary year to year. The money going into this has to be pre-tax as there are no Roth options.
Option 5: A SIMPLE IRA is short for a Savings Incentive Match Plan for Employees. A SIMPLE is available to an employer of less than 100 employees. There are 2 options for this. The first option is that the employer can contribute 2% of the employee’s salary up to the annual limit of $285,000. The second option is that the employer can match employee’s contribution up to 3% with no salary limit. What happens if you move jobs and want to move this money with you? During the first 2 years you can only roll the money over to another SIMPLE IRA. After that 2-year window, you can rollover to a traditional IRA or another employer-sponsored retirement plan. You are also allowed to roll it into a Roth IRA after the 2-year restriction but must include any money that you previously weren’t taxed on in your income for that year. (4)
Option 6: The Defined Benefit Plan is much like a self-established pension. The employer of any size of company will contribute to this plan. The employees may be required or have the option to contribute. Employers can contribute more annually to this plan than any other option. Subsequently, this will reduce their income by more for tax purposes. However, defined benefit plans are often more complex and costly to establish and maintain than the other plans. The amount contributed can vary each year but not above 100% of the participant's average compensation for his or her highest 3 consecutive calendar years or $230,000. You can have other retirement plans in addition to this plan. (4)
Keep in mind that these options are vehicles or ways to save your money. Think of them as a box or package. You choose the size, style and color of box that work best for you and fits your situation. After this decision is made, then you can decide what types of investments that you would like to put into that container. Still confused or not sure which would be the best for your own personal situations, give us a call. We would be happy to help!
- https://money.usnews.com/money/retirement/slideshows/ways-to-avoid-the-ira-early-withdrawal-penalty?
- https://www.mysolo401k.net/solo-401k/solo-401k-contribution-limits-and-types/
- (https://www.kiplinger.com/article/retirement/T001-C000-S001-how-much-can-you-contribute-to-a-solo-401-k-2020.html)
- https://www.irs.gov/retirement-plans
By Greg Johnson
As a small business owner, you will have plenty of options on ways to save for your retirement but understanding what you are trying to get out of your retirement plan is the most important. Are you wanting to attract and retain quality employees, are you wanting to maximize your contribution amounts, or are you not sure yet? Get really clear on what outcome gives you the most benefit and then work with an advisor to help you determine the most suitable path. You have the ability to really save on taxes if you build your plan properly, so don’t think you have to do this planning on your own. Work with a qualified advisor to help you determine what is right for you.