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 easy to do – and for some 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 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% in federal income taxes alone on part of your earnings. At a 35% marginal tax rate, a $50,000 retirement contribution would save you $17,500 in federal income taxes.
From just $107.88 $24.99 for Kiplinger Personal Finance
Be a smarter, better informed investor.
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
If you have a calendar-year partnership or S Corporation and filed an extension, you have until Sept. 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 Oct. 15 to file your 2021 federal income tax return. This gives you plenty of 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
Cash balance 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 Sept. 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 generate the savings and investment returns they will need to comfortably retire. I recommend to my clients that they contribute at least 10% to 15% annually, enabling them to accomplish that goal.
-
S&P 500 Hits New Highs as Rally Resumes: Stock Market TodayTech stocks were the biggest gainers on Wall Street today, with Nvidia and Dell making notable moves.
-
The Shutdown Standoff Is Heading for Its Next Big TestA key mid-October deadline could intensify the shutdown fight in Washington, and the fallout could soon hit workers and your wallet.
-
Preferred Bank Stocks: The Investment Retirees (and Others) May Be Missing Out OnMost large banks issue preferred stocks that pay out fixed dividends, often with higher yields than bonds. Should you make room for them in your portfolio?
-
Don't Let Your Equity Compensation Trip You Up: A Financial Expert's GuideStock options, RSUs and other executive perks can come with some serious strings attached. To avoid a nasty tax surprise, you need a plan.
-
The Spendthrift Trap: Here's One Way to Protect Your Legacy From an Irresponsible HeirA spendthrift clause in an estate plan can protect an inheritance from a financially irresponsible child's debts and poor decisions.
-
Adapting to AI's Evolving Landscape: A Survival Guide for BusinessesLike it or not, AI is here to stay, and opting out could be disastrous for your organization. Instead, focus on what you can control and be flexible, as AI is still evolving.
-
Striking Gold (or Gas): A Financial Pro Unpacks the Nuances of Energy InvestingInvesting in the energy industry, particularly oil and gas, involves understanding the facts about how projects generate returns through cash flow and long-term asset building, while also being aware of the risks.
-
Escaping the New Golden Handcuffs: A Financial Expert Has a Plan for Today's ExecutivesFeeling stuck in your job? It could be your complicated compensation package, but it also could be where you live, your family or even how you view yourself.
-
I'm a Financial Planner: Here's How to Invest Like the Wealthy, Even if You Don't Have MillionsPrivate market investments, once exclusive to the ultra-wealthy and institutions, have become more accessible to individual investors, thanks to regulatory changes and new investment structures.
-
Four Ways a Massive Emergency Fund Can Hurt You More Than It HelpsSaving too much could mean you're missing opportunities to put your money to work. Redirect some of that money toward paying off debt, building retirement funds, fulfilling a dream or investing in higher-growth options.
