Tax reform has been a major topic of conversation over the last fiscal year. Regardless of whether rates, deductions or exclusions change, it is always worthwhile to review your retirement planning opportunities. Especially as we enter the 4th quarter of 2021, identifying how much to save, and which investment vehicle to utilize is crucial to any tax planning strategy. Below is a brief primer on the different retirement plans to consider, detailing contribution limits, deadlines and calculations. There is no one-size-fits-all solution when it comes to retirement planning and we are here to help you navigate your options.
A Traditional 401(k) plan offered through an employer is one of the most common types of retirement accounts. Employees defer a portion of their salaries, on a pre-tax basis, into the plan. The employer can make matching contributions to the employees’ accounts as well, typically on a systematic basis, such as 50% of employee contributions up to 3% of salary. The current contribution limit for employee deferrals is $19,500; employees aged 50 or older can defer an additional $6,500, known as a ‘catch-up’ contribution. In a Traditional 401(k), employee deferrals reduce Federal taxable wages on Form W-2, and the account grows, tax-free, until amounts are withdrawn.
Many employers also offer a ROTH 401(k), which includes the same contribution limits above, except contributions are not deferrals – they are made with post-tax dollars. In the ROTH 401(k), federal wages are not reduced by the contributions, but future withdrawals are tax-free. For both the Traditional 401(k) and ROTH 401(k), the contributions must be made by December 31.
Individual Retirement Account (IRA)
Individual retirement accounts are not offered through an employer. Rather, the account is established by an individual. There are two types of IRAS: traditional and Roth. The taxability of traditional and Roth IRAs is like 401(k)s. There are a few differences between IRAs and 401(k)s. One significant difference is the annual contribution limits. The maximum amount one can contribute to either a traditional or ROTH IRA is $6,000 ($7,000 for those aged 50+). ROTH IRA contributions may be disallowed for single taxpayers with adjusted gross income (AGI) above $139,000 for tax year 2020 or $140,000 for tax year 2021; and, disallowed for married taxpayers with adjusted gross income (AGI) above $206,000 for tax year 2020 or $208,000 for tax year 2021.
There are no such income restrictions for Traditional IRAs. Contributions to an IRA can be made during the calendar year in question and up through April 15 of the following year.
Simplified Employee Pension (SEP) IRA
A SEP-IRA is a tax-deferred retirement plan established by employers for the benefit of its employees and owners. Employers make contributions on behalf of eligible employees. Employees, except for business owners, are not able to contribute to the plan. Annual contributions cannot exceed the lesser of 25% of the owner’s salary or $57,000 in 2020 or $58,000 in 2021. For self-employed individuals, contributions are generally limited to 20% of net income. In either scenario, however, the owner must contribute the same percentage to both the owner(s) and employees. Contributions to a SEP can be made up through the tax filing deadline (inclusive of extensions).
WM Wisdom: SEP contributions for sole proprietors may be impacted if the business were to elect to be taxed as an S corporation. Generally, SEP contribution limits for a sole proprietor are based on net income. SEP contribution limits for an S corporation owner are based on the owner’s salary, which may be far less than the net income as a sole proprietor.
A SIMPLE 401(k) is like a traditional 401(k) except that employer contributions are mandatory, not discretionary. An employee can defer a maximum of $13,500 (with $3,000 of catch-up contributions at age 50+). Employers are required to match either dollar-for-dollar up to 3% of pay, or a 2% non-elective contribution for each eligible employee. Contributions to the plan are due by December 31.
A solo 401(k), which is similar to a Traditional 401(k), is designed for self-employed business owners with no employees. In a Solo 401(k), the only employees can be the owner and the owner’s spouse. As an employee, the owner can defer up to the maximum $19,500 ($26,000 if age 50+). As an employer, the owner can contribute up to 25% of compensation (with the maximum contributed amount equal to $58,000 for 2021). In that respect, the total amount contributed in a Solo 401(k) is the same as in a SEP. Also, contributions to the plan are due by December 31.
The main difference between the two plans centers on employees: a Solo 401(k) is not available if there are non-owner/owner’s spouse employees, and in a SEP, contributions must be made on behalf of employees at the same percentage the owner contributes into his or her plan.
Know Your Retirement Planning Options
There are various retirement planning options available for individuals and business owners and no one-size-fits-all approach. There are pros and cons to each type of plan, and the best solution is one specifically tailored to your situation. Our team at Wouch Maloney is ready to help you evaluate these options and choose the plan best suited to help accomplish your overall goals.
Adrienne Straccione, CPA contributed to this article.
DISCLAIMER: The WM Daily Update COVID-19, COVID-19 Business Resources and COVID-19 Client News Alerts and other related communications are intended to provide general information on legislative COVID-19 relief measures as of the date of this communication and may reference information from reputable sources. Although our firm has made every reasonable effort to ensure that the information provided is accurate, we make no warranties, expressed or implied, on the information provided. As legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that may modify some of the provisions in this communication. Some of those modifications may be significant. As such, be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed.