fbpx

What are the best retirement accounts to maximize your tax savings?

Did you know that one of the best ways you can reduce taxable income is through a retirement account?

One of the best ways for business owners to reduce their taxable income (and build personal wealth) is to contribute to their own retirement plan. One note for business owners to be aware of is that if the business currently employs W2 employees, then a business owner contributing to a retirement plan may be disallowed per IRS/ERISA rules.

Fortunately, business owners who qualify have several options to choose from below:

SEP IRA – If you are self-employed, you can contribute 25 percent of your self-employment earnings into a SEP IRA, per year, with a maximum contribution of $58,000 for 2021. There are no catch-up contributions for SEP IRAs. With no year-end deadline, a SEP IRA can be set up just before filing your taxes for the previous year.

Solo 401(k) – If you are your only employee, you can easily set up a Solo 401(k) to contribute to before December 31. If you have elected S-Corp status, you will need to have payroll set up and run this 401(k) contribution through payroll to properly report on your W2. If your business qualifies for a 401(k), contributing to this retirement plan allows a business owner to take advantage of putting up to $19,500 (for 2021) into a Roth 401 (k) (post-tax) as an employee deferral, which can be beneficial for those looking to max out Roth contributions annually. Additionally, the business can match up to 100 percent of your employee deferral amount and contribute profit-sharing up to 25 percent of your W2 salary – up to a maximum of $58,000 (or $64,00 for those over 50). The match and profit-sharing are both pre-tax contributions that your business gets to expense and help lower the business’s taxable income for the year. Also, if your spouse works with you in the business, he or she can be included in this plan, essentially doubling the amount your household can contribute to retirement and helping the business with additional tax savings.

Defined-Benefit Pension Plan – For those needing huge tax savings, the defined-benefit pension plan, also known as a cash-balance plan, is king. Combine it with a 401(k) profit-sharing plan, and your business could sock away a few hundred thousand dollars per year. However, defined benefit pension plans are the most complicated of the business retirement plans to set up because the plan design is complex, time-consuming, has costs involved, and generally requires a five-year contribution commitment. A defined benefit plan is worth setting up for higher-income business owners willing and able to max out contributions to both their 401(k) and defined benefit plans, as contribution limits can be in the six figures annually depending on the business owner’s age and W2 income.

More Tax Tips

Want more tax tips like this before year-end? Download our new, Year-End Tax Planning Guide today. 

Chase