February 18, 2022
Self-employed individuals have different tax-favors options of retirement plans, including solo 401(k), traditional or Roth IRA, SEP plan, and SIMPLE plan. Through tax planning, self-employed taxpayers can benefit from tax savings on deductible contributions and tax-deferred distributions. You can generally contribute to your retirement accounts below and designate it to year 2021 if you contribute by April 15th, 2022 (or October 15th, if an extension is filed). Each plan has advantages and disadvantages, and taxpayers can make decisions based on their business type and retirement needs.
Solo 401(k)s
A sole-owner 401(k) covers only the owner or the owner plus the spouse. This plan allows a contribution to the owner as both an employer and as an employee. Therefore, it may provide the largest deductible contribution, including:
Employee contribution: Lesser of 100 percent of self-employed income or $19,500 ($26,000 for taxpayers aged 50 or over) for 2021 ($20,500 or $27,000 for 2022); and
Employer contribution: up to 25 percent of compensation.
The maximum contribution for a solo 401(k) for taxpayer is $58,000 ($64,500 for taxpayers aged 50 or over) in 2021 ($61,000 or $67,500 in 2022).
Traditional or Roth IRA
With a traditional IRA, a taxpayer can deduct the taxes on contributions on the tax return or not deduct the taxes with elections. The taxpayer pays taxes when receiving distributions. There is no age limit for making contributions, and distributions are required when taxpayers are 72. A Roth IRA is generally subjected to the same rules of a traditional IRA. However, with a Roth IRA, a taxpayer cannot deduct the taxes on contributions, but qualified distributions are tax-free.
Total contribution limits for the traditional and Roth IRA are the lesser of $6,000 ($7,000 for taxpayers aged 50 or older), or their taxable compensation of the year. There is no change in the contribution limits for 2022. Additionally, the taxpayer's Roth IRA contribution can also be limited based on their filing status and income.
Simplified Employee Pensions (SEPs)
A SEP (Simplified Employee Pension Plan) IRA is a type of IRA for small business owners or self-employed individuals. This type of IRA allows the employer to make contributions to the accounts set up for employees. Contributions are tax-deductible and earnings are not taxable until withdrawal. In 2021, employers can contribute up to 25% of income or $58,000, whichever is less ($61,000 in 2022).
SIMPLE IRA Plan
A SIMPLE IRA plan (Savings Incentive Match Plan for Employees) allows employees and employers to contribute to traditional IRAs set up for employees. Contributions to SIMPLE IRA are tax-deductible. Employers are required to make contributions each year and employees can choose to contribute or not. SIMPLE IRA follows the same investment, distribution, and rollover rules as traditional IRA. SIMPLE IRA is available to any small business, generally with 100 or fewer employees. The maximum contribution amount is $13,500 (16,500 for employees aged 50 or over) in 2021 ($14,000 or $17,000 in 2022).
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