If you are a business owner, independent contractor, or sole proprietor, you may be looking for more ways to minimize your taxes. One of the biggest tax-planning strategies that small business owners ignore is the Solo 401(k). You could save tens of thousands of dollars in taxes if you qualify annually.
As a tax-planning financial planner, minimizing the tax drag on your business could be the difference between running a highly profitable business and barely keeping the lights on.
Solo 401(k) Contribution Limits for 2022
With a Solo 401(k), small business owners can contribute as both employees and employers. Maximizing your Solo 401(k) can lead to substantial tax savings. As a Los Angeles financial planner, many of my highest-earning clients save 50 cents on the dollar for their 401(k) contributions (when combining Federal and California taxes). Would you rather write a check to the IRS or your financial future?
For 2022, the maximum contribution to a regular 401(k) is $20,500. As a business owner, you can potentially take that up to $61,000 (contribution as employer and employee). Thanks to the additional catch-up contributions, that number increases by $6,500 if you are 50 or older. This brings the total Solo 401(k) contribution limit for 2022 up to a whopping $67,500 for some business owners.
Talk with your tax-planning financial planner and CPA to determine how much you and your small business can contribute to a Solo 401(k) in 2022. Your employer contribution limit will depend on your net income, your age in 2022, and your business structure. As an employee, you can contribute 100% of your income up to the $20,5000 limit. The additional catch-up contribution is only available to those who are 50 or older at some point in 2022.
What Is a Solo 401(k)?
A Solo 401(k) is a retirement account designed specifically for small business owners without full-time employees. The exception is if your spouse also works in the business. In this case, you could each potentially have your own Solo 401(k) account. The IRS will prohibit using a Solo 401(k) if you have employees beyond a spouse.
You may jump for joy when you see how the Solo 401(k) can reduce your taxes.
How Does a Solo 401(k) Lower Your Tax Bill?
Your contributions to a Solo 401(k) are made pre-tax. You won’t owe income taxes on the funds you contribute to your retirement plan.
The goal would be to make contributions today when you are in a higher tax bracket. Later, take distributions and pay taxes when you may be in a lower tax bracket. Funds will need to stay in the Solo 401(k) retirement account until you reach the age of 59 ½, or your withdrawals will be taxable and incur an additional 10% early withdrawal penalty.
Why Don’t More People Know About the Solo 401(k)?
While Solo 401(k) plans have grown in popularity in the past few years, they are still not as widely used as other retirement accounts like a traditional IRA or SEP IRA. Sadly, some advisors don’t recommend these valuable retirement plans because they are not allowed to “sell” them. Or, in some cases, they are lazy and don’t want to deal with the extra paperwork their firms require to open these accounts. In my opinion, it is a breach of fiduciary duty to cost a client tens of thousands of dollars in taxes to avoid dealing with onerous paperwork.
Bottom line, if your financial advisor is not willing or able to give you advice about a Solo 401(k), it is probably time to find a new financial advisor. You work too hard not to get the best tax planning and retirement planning guidance. Especially when skipping this advice will increase your taxes every year.
For even more tax savings, check out the Cash Balance Pension Plan. You may be able to shelter several hundred thousand dollars of income each year.