Business owners have a variety of options when it comes to maximizing their deductions among different categories. For a greater illustration of what these categories look like, I will share a few of the most popular ways you can invest for retirement as a business owner. When done correctly, you can maximize your deductions, get the most out of your investing, and have complete financial peace-of-mind once retirement rolls around. Let’s go over the options you have as an business owner/entrepreneur running a small business!
High Income Earner: Solo 401(k)
If you are the sole owner/operator of your business, consider opening a Solo 401(k). Contribution limits for 2023 are $22,500. Additionally, you can contribute 25% of your income up to $66,000. Solo 401(k) contributions help lower your taxable income if you choose the pre-tax option. High contribution limits can offer you more financial freedom in your future if you choose to go this route.
Example: Let’s say you are a lawyer who makes $200,000 a year. You have no employees and are also the sole owner and operator of your practice. You could contribute $66,000 to your solo 401(k). Thus, lowering your taxable income from $200,000 to $134,000, –which makes a huge difference come tax time!
Simplified Employee Pension (SEP) IRA
A SEP IRA is an attractive retirement plan option for business owners, given they have a lot less paperwork, offer greater flexibility, and offer you the power to contribute significantly more than you could in a traditional IRA. This type of qualified retirement plan is a great option for a small business.
To have a SEP IRA you must either be a Sole Proprietor, Partnership, or Corporation. 2023 Contribution limits for a SEP IRA differ from the Solo 401(k).With the SEP IRA, you are allowed to contribute the lesser of 25% of employee compensation or $66,000, whichever is less. The catch with a SEP is if you decide to contribute 25% of your income you must also contribute 25% of your employee’s income on their behalf. However, you can decide what years to contribute to the plan, meaning you can skip contributions for a low income earning year.
This type of retirement plan is one where only the employer contributes and gains the tax deduction benefit at the end of the year, while the employees simply enjoy the benefit of their employer contributing on their behalf.
Savings Incentive Match Plan for Employees (SIMPLE) IRA
A SIMPLE IRA is also a great option for small businesses — as an entrepreneur, you may consider this option if you are looking for a tax deduction while saving for retirement. This option also requires minimal paperwork to file, which is an added bonus! With a SIMPLE IRA, your business can claim all the contributions as a tax deduction come tax time.
The 2023 contribution limits for a SIMPLE IRA are $15,500 a year. Entrepreneurs seeking less paperwork and flexible investment options should consider a SIMPLE IRA. Unlike the SEP, with a SIMPLE IRA employers and employees can contribute to the plan. It’s important to note this plan makes employer contributions mandatory. Contributions can be made one of two ways:
Employers can choose to match employee contributions up to 3% of their salary.
Employers make an automatic 2% contribution of their employee’s salary in their Simple IRA. In this option, employees are not required to contribute to receive their 2% of contributions.
Traditional 401(k)
For owners who have employees or want some of the highest legal IRS contribution limits, a traditional 401(k) is by far the most popular option to choose from. As a business owner, any of your employer contributions are a tax deduction for your business. Remember, tax deductions reduce your taxable income and therefore reduce the amount of taxes you owe at the end of the year. A business owner can put the 2023 legal limit of $22,500 in their personal 401(k), and as an employer can contribute up to 100% of their employee’s compensation or $66,000, whichever is less for each employee (this is a combined employee/employer contribution). If you are a highly profitable business, this accumulates a large amount of deductions at the end of the year for your company.
Retirement Plan Startup Credit
With the exception of the Solo 410(k), all of these options are able to receive a Retirement Plan Startup Costs credit. This allows you to claim a tax credit of up to $5,000 if you started any of the qualified retirement plans. As a reminder, credits are great because they reduce the amount of taxes you may owe on a dollar-for-dollar basis.
Which Option is Best?
With lots of options to choose from, we only covered the four most popular choices for business owners. You may be wondering what option is best for you and your business. Our team specializes in communicating and educating business owners on what options are the most suitable for them and walk alongside them as they start this new journey to gaining financial peace. If you are ready to start a qualified retirement plan while maximizing your tax deductions, please reach out to our team at KerberRose Wealth Management and we will be happy to assist you and your company!
About Alex
Alex is one of our financial wellness advocates on our Wealth Management team. She is a mom of four, and her passion is sharing her own personal finance journey from living paycheck to paycheck and drowning in debt to finding financial peace. Alex's unique experience has given her the ability to help families take control of their own personal finances - all while still enjoying what life has to offer.
Contact: alex.miller@kerberrose.com