By Maggie Rapplean, CFP®, Senior Advisor, Moneta
Solo entrepreneurs, business owners and professionals often work days, nights and weekends. They may not have time to put together a financial plan that would save a significant amount of their income for retirement while also cutting their taxes by possibly tens of thousands of dollars each year. But it’s often easy to do – and there is still time to do this and file your 2021 taxes on time if you filed an extension.
Consider this scenario:
You work as a medical doctor, attorney, real estate professional or tech company owner and earned $500,000 in 2021. If you are married and file a joint return, you and your spouse will pay a marginal income tax rate of 35 percent in federal income taxes alone on part of your earnings. At a 35 percent marginal tax rate, a $50,000 retirement contribution would save you $17,500 in federal income taxes.
If you have a calendar-year partnership or S Corporation and filed an extension, you have until September 15 to file the 2021 federal business return. If you have a Schedule C on your Form 1040 and filed an extension, you have until October 15 to file your 2021 federal income tax return. You still have time to start one or more new retirement savings plans – a way to build long-term wealth – while potentially making a huge dent in your tax bill.
Here’s a quick summary of some of the retirement plans available to you:
A Simplified Employee Pension (SEP). A SEP allows a small business owner to set up and contribute to a SEP Individual Retirement Account (SEP IRA). Contributions to a SEP are limited to approximately 20% of your net earnings from self-employment (or 25% of your W-2 wages if you have an S Corporation) with a limit of $58,000 for 2021 and $61,000 for the 2022 tax year. Business owners who haven’t yet filed their 2021 returns still have time to contribute to one of these plans until the extended due date.
A Solo 401(k) Retirement Plan. This is a retirement account designed for self-employed business owners with no other employees (besides a spouse). While the deadline has passed to make an “elective deferral” contribution for the 2021 tax year, there is still time to make an election to adopt a plan for the 2021 tax year, which would allow the “employer” contribution for 2021.
If you were paid a sufficient salary or had sufficient net earnings from self-employment (depending on entity type), the “employer” can contribute up to $58,000 for the 2021 tax year and $61,000 for the 2022 tax year. In future years when an “elective deferral” is possible, a catch-up contribution of an extra $6,500 is available for those 50 or older.
Cash Balance Plans. These plans give one more option for retirement and tax savings for solo business owners with high incomes – such as those already maximizing the 401(k) plan or SEP IRA. If you extended your return, you have until September 15 to still make contributions to a cash balance plan for the 2021 tax year (a Schedule C does not get an extra month like the other plans).
These plans are different from SEPs and 401(k)s because they are defined benefit plans instead of defined contribution plans and will require a contribution each year. The maximum amount you can contribute is dependent on your age and the terms of the plan (you work with an actuary to determine the contribution), but over time may allow larger and larger contributions. These plans can be combined with a 401(k) to allow even higher contributions, though you will have to coordinate the overall contributions between the plans.
With a combined plan, you could be contributing more than $100,000 annually to retirement (and sometimes much more). In addition to helping a solo owner quickly build wealth, a cash balance plan has other benefits. For example, once the owner retires, they have the option of taking these savings in an annuity spread out over several years or as a lump sum, which can be invested.
It’s clear that by contributing to one or more of these plans, entrepreneurs and solo small business owners can likely generate the savings and investment returns they will need to comfortably retire. Generally, I recommend to my clients that they contribute at least 10-15 percent annually, enabling them to accomplish that goal.
If you are a small business owner, medical doctor, attorney, or real estate professional with questions or would like to discuss a strategy for retirement and tax savings, please contact me at MRapplean@monetagroup.com. We offer a free consultation to discuss how a comprehensive financial plan can serve you well now and during retirement.
© 2022 Moneta Group Investment Advisors, LLC is an SEC registered investment advisor and wholly owned subsidiary of Moneta Group, LLC. Registration as an investment advisor does not imply a certain level of skill or training. The information contained herein is for informational purposes only, is not intended to be comprehensive or exclusive, and is based on materials deemed reliable, but the accuracy of which has not been verified. Examples contained herein are for illustrative purposes only based on generic assumptions. Given the dynamic nature of the subject matter and the environment in which this communication was written, the information and opinions contained herein are subject to change. This is not an offer to sell or buy securities, nor does it represent any specific recommendation. You should consult with an appropriately credentialed professional before making any financial, investment, tax, or legal decision. Past performance is not indicative of future returns. All investments are subject to a risk of loss. Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. These materials do not take into consideration your personal circumstances, financial or otherwise.
