If you’re serious about increasing your retirement savings and minimizing income taxes, the best thing to do is get a late-career professional in private practice. As you earn a lot of money and approach retirement age, you have savings options that go well beyond the levels of the typical workplace 401(k) plan.
But you can also save more and lower your tax burden if you’re a rideshare driver, nanny, or just anyone with a side hustle. As long as you can handle a little extra paperwork and some fees, you can set up a solo retirement plan and enjoy higher limits than most employees.
The IRS recently announced new maximum retirement contribution levels for 2023, and most people are focused on the amount allowed for employee deferrals in a 401(k) plan, which will be $22,500, with $7,500 additional for those 50 and over. For traditional IRAs and Roths, it’s $6,500 with an additional $1,000 for catch-ups.
You get higher numbers when you are both employee and employer. For SEP IRAs or solo 401(k) plans, which are designed for those who file Schedule C for self-employment income, you can carry forward up to the total allowable limit for employee and employer, which will be $66,000 for 2023, plus the Catch-up contribution of $7,500. For cash balance retirement plans, a type of defined benefit plan you can set up for yourself as a solo practitioner, the IRS says you can defer up to $265,000.
“Not everyone can save more for retirement, but if you can, it increases the amount you can save,” says Tom Balcom, a licensed financial adviser who runs 1650 Wealth Management in Lauderdale- by-the-Sea, Florida, and who uses a cash balance retirement plan for his own retirement savings.
Higher ceilings for high earners
The reason you can have such a high limit for cash balance retirement plans is that they are calculated by a different system than the standard 401(k). A defined benefit plan focuses on the amount of benefits and uses actuarial calculations based on the member’s age and income to determine what the contribution may be for the year. Thus, an older person who earns a lot of money can save a lot more than a younger person who earns a starting salary.
If that sounds complicated, that’s because it is. You can’t do the actuarial calculations yourself, so you have to hire a third-party administrator at a cost of several thousand dollars a year.
Individual entrepreneurs who make this decision usually consider it after considering several other plan options. They can start in their younger years with a plan with a lower deferral amount, then switch when their age and income justify the higher numbers.
Most don’t start at all, of course. Only 13% of the self-employed participate in a pension plan compared to 75% of traditional workers, according to an analysis by Pew Charitable Trusts.
The end game with a cash balance plan isn’t necessarily getting an annuity-like payout like you would with a pension. Your income accumulates in an account much like a 401(k) and most users plan to transfer the funds into an IRA in retirement and manage the accounts themselves.
“The flexibility of switching to the IRA is great in the long run,” Balcom says. “I can make money by the way I structure the portfolio.”
Opening and maintaining a SEP IRA or solo 401(k) is much easier. For example, you can start a Single(k)Plus plan at Ubiquity Retirement + Savings for $350, with a monthly fee of $35 and recurring investment fees, says Chad Parks, founder and CEO of Ubiquity Retirement + Savings. . You can also get these plans from most major brokerages, such as Fidelity, Schwab, and Vanguard, with features and costs varying by provider.
For these plans, you can first contribute up to the maximum allowed amount of $22,500 as an employee, then you can contribute more as an employer. For a SEP, it’s 25% of your net self-employment income up to the maximum combined limit of $66,000 for 2023. For a solo 401(k), you can contribute all of your self-employment earnings. self-employment, up to the maximum combined limit of $66,000 in 2023, so most of the time this equates to a higher dollar amount than the SEP.
If you have side money you want to contribute, be sure to coordinate it with contributions you and your primary employer make to other accounts, says Sean Mullaney, financial planner and CPA based in Woodland Hills, Calif. , and author of a new book on 401(k) solo. “The limits are per person, not per plan,” Mullaney explains.
Mullaney calculates that it would take about $230,000 in Schedule C income to max out a solo 401(k) in 2023. For those who file with an S corporation, they can reach $174,000 in W-2 income. .
Even more tax benefits
Those who benefit the most from this approach exceed the income cap for the 20% qualified business income (QBI) deduction, which was put in place in 2018 as part of the Tax Cuts and Job Act. This limit was $170,050 for single filers and $340,100 for joint filers in 2022.
“A lot of high-income professionals are left out,” Mullaney says.
This is where tax planning comes in. If you report enough income to fall below the limit, you can get up to an additional 20% off your tax bill.
“The game becomes deduce, deduce, deduce as you work,” says Mullaney.
There’s still time to calculate your 2022 earnings and plan for self-employed retirement deferrals before the end of this year. If you set up the kind of plan you want now, you have until your tax return deadline to make your contributions for 2022, and then you can switch in 2023 to the new, higher limits.
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