Being a small business owner is no small feat. It’s easy to fall into the trap of being so busy making things run that you forget about yourself—specifically your retirement! Yet saving for retirement is one of the most important things you can do; though you may love what you do in your business, you have to retire someday. Today let’s talk about some steps you can take to save for retirement and reduce your taxes while running the business you love.
The Business Is My Retirement Plan
It’s quite possible that your business may be the biggest asset you own.Many business owners believe that the sale of their business will give them the funds to retire, without knowing what it’s actually worth or having an exit strategy in place. Your business can be a viable source for a full and happy retirement with the proper planning and knowledge of what deductions you can take in order to reduce your taxes. It’s important to know that planning to sell your business to fund retirement requires preparing well in advance, many years before retirement. Creating a diversified strategy to solidify your business assets allows you to build into the foundation for your retirement.
Traditional and Roth IRAs
You have plenty of choices to help reduce your small business taxes, and one way to start is with a traditional IRA. If another plan does not cover you or your spouse, your contribution is deductible, which will help lower your taxable income. For 2023, the contribution limits are $6,500 for individuals, with a $1,000 catch-up contribution for those age 50 and older. In a traditional IRA, money is taxed when it’s withdrawn, but realize that if you take money out of your IRA before age 59½, you will incur a 10% penalty on top of the taxes you must pay. Conversely, a Roth IRA cannot be used as a deduction on your tax return because it is funded with after-tax dollars.
Another vehicle small business owners can use to save for retirement are Simplified Employee Pensions, more commonly referred to as SEP IRAs. A SEP allows an employer to contribute money directly to an IRA set up for each employee, where the contributions are tax-deductible to the employer.
If you are self-employed, deduction limits will differ. Employers can contribute up to 25% of an employee’s salary to their SEP IRA each year, up to a maximum of $66,000 for 2023. The percentage used for contributions must be the same for all participants. Employees must be included in the SEP if they are 21 years old and worked for your business in at least 3 of the past 5 years. There are also compensation minimums for eligible employees, which are $750 for 2022, $650 for 2021, and $600 for years 2020-2016.
That being said, you can use less restrictive requirements to include more employees in the plan. The contribution to your SEP does not affect how much you can contribute to a traditional or Roth IRA. If you need clarification on any of these rules, don't hesitate to reach out.
Solo 401(k) or Self-Employed 401(k) Plans
If you are a contractor or sole proprietor, then a solo 401(k) or self-employed 401(k) plan could be a good option for you and your spouse if they are your only employee. You can make an employee deferral of 100% of your compensation or $22,500 for 2023, whichever is smaller. If you’re 50 or older, you can contribute an additional $7,500 for 2023. You can also contribute as the employer up to 25% of compensation, not to exceed the overall contribution limit of $66,000 for 2023. These contributions are tax-deductible. A solo 401(k) does not require a Form 5500 unless the account exceeds $250,000.
How Wilkinson Wealth Management Can Help With Your Retirement
Unfortunately, a third of small business owners do not have a retirement plan. That’s an astounding figure because there are nearly 31 million small businesses in the United States, and about 51% of all small business owners are 50 or older. If you don’t have a retirement plan, our team can help you set up a traditional or Roth IRA, SEP IRA, or solo 401(k), and several other types of plans that can help you save for retirement. If you’re ready to start planning for your future with support on tax-reduction strategies, reach out to us at 434-202-2521 or use our Contact Us page to schedule an appointment.
Peter Mindnich is a financial advisor and Manager of Client Relations for Wilkinson Wealth Management, a financial services firm in Charlottesville, Virginia, providing customized financial planning and investment strategies with a personal approach. He has a B.A. in American History from the University of Vermont, his series 7 and series 66 licenses, and experience with client relations and customer service across a plethora of industries. In addition to his role in client relationship management, he assists our head of Research and Analytics, Frank, with investment trading support. As an advisor, Peter specializes in several personal finance needs, such as portfolio management, fixed income, and retirement planning. Outside of work, Peter enjoys the outdoors, family, playing with his dog, and playing the guitar.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.