Owning your own business means you are in control of what retirement accounts you use. The issue is that there are so many options available which can get overwhelming and lead to a lack of action. Let me help you with this. Let’s look at what options you have and why each could be the best for you!
1. Solo 401(k)
- What is a solo 401(k) – A solo 401(k) is exactly what it sounds like, it is a retirement plan for those who own their own individual business and have no workers. The only way you can have another employee and still use a Solo 401(k) is when they are your spouse! Solo 401(k)’s have both pre-tax and ROTH options making them very attractive.
- Contribution Limits – You are able to contribute up to $61,000 a year (for 2022) into your solo 401(k) if you are under the age of 50. You can put in up to 100% of your total compensation (up to $22,500). Plus, as the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income. The high contribution limits are what people love about this option!
- Who is this good for? – This account is great for business owners who have no employees or just their spouse. It is my favorite option if it applies to you.
- What is a 401(k) – a 401(k) is employer sponsored defined-contribution plan. You can make contributions on a pre-tax basis, meaning it reduces your taxable income today, but that money will be taxed at your income tax rate when you pull the money out in retirement. With a 401(k), you as the employer, has the option to match a certain amount of the contributions you put in but not all do it.
- You also have the ability to use a ROTH 401(k) and put your contributions in on after-tax basis.
- Contribution Limits – With a 401(k) you can put up to $22,500 a year in (starting in 2023) if you are under the age of 50, but you cannot take this money out until you are 59.5 without a 10% penalty and paying taxes.
- There is an exception to this called Rule 72t where allows you to take withdrawals before age 59.5 without a 10% penalty. Read more about it here.
- Who is this good for? – 401(k)’s are typically more expensive than the other retirement account options. They make sense for businesses who have more than a handful of employees.
- Options as the employer – You can choose to have no match all the way up to a high match on the contributions your employees put in. Just make sure to follow the safe harbor rules.
3. Simple IRA
- What is a Simple IRA – It is for people who work at a small business with less than a 100 employees. This account is very similar to a 401(k).
- Contribution Limits – You can contribute up to $14,000 for the 2022 tax year to your Simple IRA if you are under the age of 50. The employer then has two match options to choose from.
- Option 1 – Dollar-for-dollar match of employee contributions up to 3% of each employee’s compensation (which can be reduced to as low as 1% in any 2 of 5 years)
- Option 2 – A contribution of 2% of each employee’s compensation. The maximum compensation used to determine this contribution is $290,000 for 2021 and $305,000 for 2022. Contributions are tax-deductible and are required every year.
4. Simplified Employee Pension IRA (SEP IRA)
- What is a SEP IRA – A Simplified Employee Pension IRA (SEP IRA) is a traditional IRA for self-employed people & small-business owners. SEP IRAs are best for small-business owners with few or no employees. The reason being, if you have employees whom the IRS considers eligible participants in your plan, you must contribute on their behalf, and those contributions must be an equal percentage of compensation to your own.
- If you match 5% of your income you also have to do the same for them!
- Eligible participants are employees who are 21 or older, have worked for you for at least three of the past five years, and have made a minimum of $650 from you.
- Contribution Limits – Those who are eligible can contribute up to 25% of their compensation or $61,000, whichever is less of the two.
What We Think About The Options You Have
- The Solo 401(k) is our favorite option, the problem is you can only use it if you are the only employee or it’s just you and your spouse. If you fit that criteria, it can be an awesome account. Fees are low, have both pre-tax and ROTH options, high contribution limits, etc.
- Solo 401(k)’s are better than SEP IRA’s. You can contribute up to 100% of your income with a Solo vs 25% with a SEP IRA. So if you make $40,000, you can max out your Solo 401(k) at $22,500 (before the employer contributions) but with a SEP IRA you could only do $10,000. Basically, you can contribute more to a Solo 401(k) at a lower income level plus it has a ROTH option.
- 401(k)’s can be a good option as you add many employees, the costs to implement and maintain one are just higher.
- SEP IRA’s are good options if you have employees, but you have to match the same amount of their income as you do for yourself.
Individual Accounts Outside of Work
1. Individual Retirement Account (IRA)
- What is an IRA? – An IRA is a pre-tax retirement account only available for those who have earned income. An IRA has the same tax benefits as a 401(k) where your contributions reduce your taxable income today and then you won’t be taxed until you withdraw the funds in retirement after age 59.5
- There is an exception to this with a spousal IRA. This is where a spouse can contribute to an IRA for their non-working spouse (or one with little income). The working spouse’s income has to be equal to or more than the total contributions between both IRA’s.
- Contribution Limits – You can contribute up to $6,000 a year into your IRA if you are under the age of 50. But you can only contribute up to how much you make. If you make $4,000 a year you can only put $4,000 into your IRA.
- Income Limits – You can only deduct your contributions if you make under a certain income level (based on your adjusted gross income). This is if you are covered by a retirement plan at work. If you are not, check out this resource to see the income limits.
- Single – Can deduct if you make $66,000. Can partially deduct if you make between $66,000-$76,000. Can’t deduct at all if you make above $76,000 AGI.
- Married filing jointly – Can deduct if you make $105,000. Can partially deduct if you make between $105,000-$125,000. Can’t deduct at all if you make above $125,000 AGI.
2. ROTH IRA
- What is a ROTH IRA – It is a post-tax individual retirement account only available to those with earned income. With a ROTH IRA you are contributing with post-tax dollars so these dollars will never be taxed again.
- The spousal rule applies here just like the traditional IRA.
- Contribution Limits – You can set aside $6,000 a year into your ROTH just like your IRA, if you are under the age of 50.
- A ROTH IRA has other rules that allows you to take out your contributions at any point without a penalty, but that does not include the growth, only your contributions. Learn more about it here.
- Income Limits – The income limits are based on your Modified Adjusted Gross Income (MAGI)
- Single – You can contribute the entire $6,000 if your MAGI is less than $125,000. The contribution begins to phase out when your MAGI is between $125,000 and $139,999. And you are no longer able to directly contribute if your MAGI is above $140,000.
- Married Filing Jointly – You can contribute the entire $6,000 if your MAGI is less than $198,000. The contribution begins to phase out when your MAGI is between $198,000 and $207,999. And you are no longer able to directly contribute if your MAGI is above $208,000.
- Note: if you are above the income limit, you can do a backdoor ROTH IRA to get ROTH contributions. This is where you put your post tax dollars into a non deductible IRA, then move it over to a ROTH IRA. Read more about this here.
3. Health Savings Account (HSA)
- What is an HSA – An HSA is meant to be used for health care costs, but it can be used to build funds for retirement or retirement health care costs. In order to be eligible for an HSA, you have to have a high-deductible health insurance plan that allows it.
- Contribution Limits – For individuals under age 55, you can contribute up to $3,650 a year and for families you can do $7,300. The contributions you put into an HSA are triple tax advantaged, meaning it reduces your taxable income today, can get invested and grow tax deferred, then be used tax free on health care costs. It is a very powerful account.
4. Taxable Account
- What is a taxable account – It is an account that doesn’t have any tax benefits, but offers fewer restrictions and more flexibility than the tax-advantaged accounts above. You can use this money whenever you want which people love about it, but you will also have to pay taxes based on how long you hold the investment for. If you hold for less than 1 year, you are taxed based on your income rate. If you hold for greater than 1 year, you are taxed at long term capital gains rates which are 0%, 15%, or 20%.
- Contribution Limits – There are none! You can contribute as much as you want.
I hope this helps you make the best decision for you and your business! If you need help picking or implementing these for your business, hit us up! We are here to help.
Disclaimer: None of this should be seen as advice, it is just for informational purposes. Consult your financial advisor, CPA, etc before implementing any new plan!