Strategies for Small Businesses and Sole Proprietors to Save Money on Taxes -Part 2 of 10
Running a small business or working as a sole proprietor means you’re often focused on the here and now—day-to-day operations, keeping cash flow steady, and getting through the next quarter. But if you’re not thinking about retirement planning, you’re leaving long-term money on the table. Not only can contributing to a retirement plan help secure your future, but it also delivers immediate tax benefits for your business today.
Here’s the good news: as a small business owner or sole proprietor, you have access to several powerful retirement plan options with tax advantages that can often outshine what larger companies offer. In this article, I’ll walk you through the best retirement contribution options out there, how they work, and the tax savings you could be looking at.
1. Retirement Plan Contributions: The Basics
Retirement contributions are a fantastic way to lower your taxable income. When you contribute to a retirement plan, those funds are either tax-deferred or tax-free (depending on the type of plan). That means you’ll either get a tax deduction now or avoid paying taxes when you take it out later in retirement.
For small business owners, contributing to retirement accounts does double duty:
- Reducing Taxable Income: Most retirement account contributions are tax-deductible, which lowers your taxable income—and might even bump you into a lower tax bracket.
- Building Long-Term Wealth: Since your retirement savings grow in a tax-advantaged environment, you’re building wealth more efficiently than in a standard taxable account.
The biggest challenge? Choosing the right plan. So, let’s go over some of the most common retirement plans and how they can help you achieve both short-term tax savings and long-term security.
2. Solo 401(k): A Powerful Tool for Sole Proprietors
If you’re self-employed or a business owner without employees (other than a spouse), the Solo 401(k) could be perfect for you. It’s got some of the highest contribution limits out there, which is a great fit if you’ve got strong cash flow and want to maximize your tax deductions.
How It Works:
As both the employer and the employee, you can contribute to a Solo 401(k) in two ways:
- Employee Contribution: Up to $22,500 in 2024 (or $30,000 if you’re 50+).
- Employer Contribution: Up to 25% of your net self-employment income.
With total contributions capped at $66,000 in 2024 (or $73,500 for 50+), a Solo 401(k) lets you contribute significantly while reducing your taxable income.
Tax Benefits:
Contributions are tax-deferred, meaning you’re only taxed when you withdraw funds in retirement. For example, if you make $100,000 and contribute $50,000 to your Solo 401(k), your taxable income drops to $50,000. And many plans offer a Roth option, so you can contribute after-tax dollars that grow and withdraw tax-free in retirement.
3. SEP IRA: Simplified for Small Business Owners
The SEP IRA offers simplicity, especially if you’re a sole proprietor or small business owner. There’s no need for the paperwork of a Solo 401(k), and it allows for substantial contributions in profitable years.
How It Works:
With a SEP IRA, you (as the employer) make contributions for yourself and any employees. If you’re solo, you’re only contributing for yourself, which can be up to 25% of your net earnings, maxing out at $66,000 in 2024.
Tax Benefits:
SEP IRA contributions are tax-deductible and grow tax-deferred, making this plan a great choice for tax-savvy savings without the administrative burden.
4. SIMPLE IRA: A Middle Ground
The SIMPLE IRA is ideal for small businesses with a few employees. It has lower contribution limits than the Solo 401(k) or SEP IRA, but it’s still a solid option if you’re looking for tax-deductible contributions without a ton of overhead.
How It Works:
Employees can contribute up to $15,500 in 2024 ($19,000 if they’re 50+), and employers can either match up to 3% of employee contributions or make a flat 2% contribution for everyone.
Tax Benefits:
Contributions are tax-deductible, and money grows tax-free until retirement. It’s simple, straightforward, and offers a nice tax advantage for small business owners looking to keep things manageable.
5. Defined Benefit Plan: High Contribution Limits for High Earners
If you’re a high-income business owner and need to contribute beyond the limits of other plans, a Defined Benefit Plan lets you put away more, potentially reducing your taxable income significantly.
How It Works:
A Defined Benefit Plan is like a traditional pension—your contributions are based on the benefit you plan to receive in retirement. The closer you are to retirement, the more you can contribute.
Tax Benefits:
This plan allows for substantial contributions (think six figures), which can be a huge tax deduction for high earners. However, it’s more complex to set up and requires consistent income to support it.
6. Health Savings Accounts (HSAs): A Bonus Savings Tool
An HSA isn’t a traditional retirement plan, but it can work like one. It comes with triple tax benefits: contributions are tax-deductible, growth is tax-free, and qualified medical withdrawals are tax-free.
How It Works:
For 2024, you can contribute up to $4,150 as an individual or $8,300 for family coverage, with an extra $1,000 if you’re 55+.
Tax Benefits:
HSAs are great for funding healthcare costs in retirement, but after age 65, you can also use them for non-medical expenses without penalty.
7. Retirement Contributions: Maximizing Your Tax Efficiency
Retirement contributions can do wonders for your tax strategy. Whether it’s a Solo 401(k), SEP IRA, or HSA, the key is to make regular contributions to reduce taxable income while building up your retirement savings.
Bottom Line
Choosing the right retirement plan can be a game-changer for small business owners and sole proprietors. Each plan has unique benefits, so it’s important to evaluate your options based on your income, business type, and retirement goals. And as always, consulting a tax professional is the best way to make sure you’re maximizing these options and staying compliant.
By building retirement contributions into your tax strategy, you’re setting yourself up for a more secure future and making your business more tax-efficient today.
