Jovan Johnson, MBA, CFP®, CPA/PFS

 

 

Owning an S Corporation offers a distinct advantage: the ability to shield substantial earnings from taxes. Most S Corp owners are familiar with the flexibility offered by the S Corp structure, which allows for owners to receive payment through both a salary and shareholder distribution. Notably, only the salary component is subject to self-employment taxes (up to 15.3%, depending on income). However, there is another avenue for significant tax savings: S Corp retirement plan options.

These retirement plans not only offer tax benefits during your earning years but also provide avenues for tax-efficient savings and withdrawals in retirement. Despite these advantages, many small business owners often neglect retirement planning. Fortunately, there are numerous S Corp retirement plan options available.

In this article, we will explore several S Corp retirement plan options suited for small business owners. However, we won’t delve into more specialized plans like the cash balance pension plan. Selecting the right retirement plan hinges on various factors, including the size of your business, the number of employees, and your financial goals. Let’s explore five S Corp retirement plan options worth considering.

1. SEP IRA

The SEP IRA is easy to establish, making it an attractive option for S Corp owners. Unlike some other plans, the SEP IRA is accessible to businesses of any size, including those with employees. However, it is important to note that if you have employees, you’re obligated to contribute the same percentage to their accounts as you do to your own.

In 2024, employers can contribute up to 25% of wages or $69,000, whichever is less. Contributions can be made on a pre-tax or Roth basis. This flexibility, coupled with the ease of setup and minimal maintenance costs, makes the SEP IRA an appealing choice. Additionally, contributions can be made to a traditional IRA or Roth IRA (if you qualify) in addition to the SEP IRA, further enhancing its versatility.

Unlike some retirement plans, SEP IRA contributions are made solely by the employer and aren’t mandatory every year. This allows for more flexibility in managing cash flow. Moreover, contributions can be made up until the tax filing deadline, including extensions, providing additional time for financial planning.

However, it’s important to consider the limitations of the SEP IRA. Catch-up contributions are not allowed and there are no provisions for loans or early withdrawals (before age 59 ½) without penalties (except under certain rare circumstances). These restrictions may impact individuals looking for more flexibility in managing their retirement funds.

Given the increased accessibility and cost-effectiveness of solo 401(k) plans, if you are a single owner S Corp (or with a spouse employee), the solo 401(k) is often the better option. We will dive into the reasons behind this recommendation below.

2. Solo 401(k) or 401(k)

A solo 401(k) is a great retirement plan option for business owners with no employees (except a spouse). This plan appeals to many entrepreneurs due to its similarity to the employer-sponsored 401(k) plans they may have been familiar with from their previous employment. Moreover, it can complement existing traditional or Roth IRAs (if you qualify), offering additional avenues for retirement savings.

With a solo 401(k), you can contribute both as the employer and the employee and contributions aren’t mandatory every year. In 2024, employees can contribute up to $23,000, or $30,500 for those aged 50 and older. Remarkably, employees can save up to 100% of their wages, up to the specified limit, into the solo 401(k) plan. As the employer, you can further increase your retirement savings with an additional contribution of up to 25% of compensation. The combined contribution cap is $69,000, or $76,500 for individuals aged 50 and above.

Similar to SEP IRAs, solo 401(k)s accommodate both pre-tax and Roth contributions. However, they offer added flexibility by permitting employee loans and hardship withdrawals. Contributions from the employer can be made until the tax filing deadline, including extensions, while employee contributions typically need to be completed by the end of the calendar year.

Despite its advantages, the solo 401(k) has some limitations. It cannot be maintained if you decide to hire employees, and once your account balance reaches $250,000, reporting requirements to the IRS come into play. Additionally, accessing funds penalty-free before age 59½ is generally restricted, except under certain circumstances.

If you anticipate expanding your business and hiring employees, transitioning to a traditional 401(k) might become necessary. However, it’s essential to be mindful of the increased regulatory requirements and associated costs, such as ERISA compliance, which are beyond the scope of this article.

3. SIMPLE IRA

The SIMPLE IRA presents another straightforward retirement plan option tailored for small business owners. Setting up this plan is hassle-free, making it an attractive choice for businesses with up to 100 employees.

In 2024, employees may contribute up to $16,000, or $19,500 for those aged 50 and older. Employers are required to make contributions to all eligible employees’ SIMPLE IRAs, either through matching or nonelective contributions.

Similar to other retirement plans like the SEP IRA and solo 401(k), the SIMPLE IRA accommodates both pre-tax and Roth contributions, providing flexibility to suit various financial preferences. Additionally, it can complement existing traditional or Roth IRAs, offering individuals multiple avenues for retirement savings.

Setting up a SIMPLE IRA is straightforward, and its maintenance costs are typically low. Employers must make contributions by the tax filing deadline, while employee contributions must be made within 30 days after the end of the tax year. However, accessing funds penalty-free before age 59½ is generally restricted, except under certain circumstances.

4. Traditional IRA

The Traditional IRA offers tax advantages for individuals across various employment scenarios, including small business owners. Opening and funding a Traditional IRA is accessible to anyone who has earned income, irrespective of employment status.

In 2024, individuals can contribute up to $7,000 or $8,000 for those aged 50 and older. These contribution limits provide individuals with opportunities to bolster their retirement savings while benefiting from potential tax advantages.

Contributions to a Traditional IRA can be either pre-tax or after-tax, contingent upon several factors. Some of these factors include whether you or your spouse are covered by an employer-sponsored retirement plan and your adjusted gross income. If either you or your spouse are covered by such a plan, the tax deductibility of contributions may vary based on your income level for the tax year.

5. Roth IRA

The Roth IRA offers tax-free withdrawals in retirement funded by after-tax contributions. Small-business owners are eligible to open and fund Roth IRAs provided they meet the income thresholds set by the IRS. Many entrepreneurs opt to contribute to a Roth IRA during years when their income falls below these thresholds.

In 2024, individuals can contribute up to $7,000 or $8,000 for those aged 50 and older. These contribution limits provide flexibility for individuals to bolster their retirement savings.

One of the most significant tax advantages of the Roth IRA lies in its tax treatment of earnings. Contributions to a Roth IRA are made with after-tax dollars, meaning withdrawals in retirement are not subject to taxation. Additionally, funds (up to your basis) in a Roth IRA can be accessed penalty- and tax-free if the account has been open for at least five years, offering additional flexibility and security in retirement planning.

Final Thoughts

In conclusion, it’s essential to recognize that each retirement plan option comes with its own set of limitations and features. S Corp owners must approach this decision with due diligence, as the choice of a retirement plan significantly impacts their financial future.

Before selecting a plan, it’s imperative to evaluate your overall financial and business goals carefully. Seeking guidance from a financial advisor or Certified Public Accountant (CPA) can provide invaluable insights tailored to your specific needs and circumstances.

By taking the time to assess your options and seek professional advice, you can make an informed decision that aligns with your long-term retirement objectives and ensures financial security in the years to come.

If you would like to learn more about any of the S Corp Retirement Plan options listed above, please feel free to schedule a Free Consultation.

Disclosures

None of the information provided is intended as investment, tax, accounting, or legal advice, as an offer or solicitation of an offer to buy or sell, or as an endorsement, of any company, security, fund, or other securities or non-securities offering. The information should not be relied upon for purposes of transacting securities or other investments. Your use of the information is at your sole risk. The content is provided ‘as is’ and without warranties, either expressed or implied. Piece of Wealth Planning LLC does not promise or guarantee any income or particular result from your use of the information contained herein.