Now that most everyone has filed their 2020 taxes, let’s review how much you can sock away in tax-deferred retirement accounts in 2021 (assuming you still have “earned income”). The IRA (and Roth IRA) contribution limits remain at $6,000 for folks who are under age 50 and $7,000 for those 50 and above. Many other retirement plan contribution limits are being increased in 2021.
Let’s have a quick review of the different retirement savings plans, and provide insights on some of the frequently asked questions about each of these plans.
401k(s) – The most popular retirement savings plan for employees
The average deferral rate among employees who participate in a 401k is 7% of their salary. Only 12% of employees defer the maximum, according to the 2019 Vanguard “How America Saves” study. The maximum (AKA: annual contribution limit) for participants in 401(k), 403(b), and 457 plans remain at $19,500 for 2021. Participants age 50 or over can contribute an additional $6,500, bringing the total to $26,000. Keep in mind that these figures are only the employee’s contribution. The total amount contributed can reach $58,000, once you add in a company match and/or profit-sharing contributions from your employer. The amount the employer can contribute increased by $1,000 in 2021.
Retirement Plans for the Self-Employed:
The Solo 401(k) is my favorite plan for self-employed individuals who do not have employees. The contribution limits are broken into two categories; the employee contribution and an employers “profit-sharing” contribution. The employee contribution is limited to $19,500 if you are under 50 or $26,000 if you are 50 or over. The profit sharing contribution is limited to 25% of gross income if you operate as a Corporation, or 20% of net income if your business is a sole proprietorship or partnership. The total contributions (employee and employer) are limited to $58,000 if you are under 50 or $64,5,000 if you are 50 or over.
You can also contribute for a spouse, provided you pay them wages from the business. You could put your spouse on payroll and then defer 100% of those wages into the solo 401k plan. Naturally, you would not pay any income tax on wages contributed to the Solo 401k, but the employee (and employer) would still have to pay payroll taxes (Social Security and Medicare withholding) on the wages.
The other very popular plan for small business owners with zero to a handful of employees is the SEP IRA. The contribution limit is $58,000 for the SEP IRA, not the $6,000-$7,000 limit you find with a Traditional or ROTH IRA. However, there is no “Catch-up” provision, so the contribution limit is the same for employees under or over 50. You must include all employees who are over age 21, have worked for your business in 3 of the past 5 years, and have received at least $600 in compensation. The employer can contribute up to 25% of wages to a SEP IRA. However, they have to contribute the same percentage for each eligible employee. So, if you contribute 15% for yourself, you have to contribute 15% of each eligible employee’s wages.
A couple other idiosyncrasies of the SEP IRA are:
- Employees are not allowed to contribute, only the employer.
- All contributions are immediately vested.
- The SEP can be instituted up to your tax filing deadline, including extensions, for the previous year. The SEP used to be the only plan that allowed this, but other plans (e.g. Solo 401k) can now be set up after 12/31 for the prior year.
The nice thing about the solo 401k and SEP IRA is the administration is extremely simple and does not require a Third Party Administrator (TPA) like a typical company retirement plan. These plans can be opened at just about any brokerage firm (TD Ameritrade, Fidelity, Schwab, or Vanguard).
Frequently Asked Questions
You probably have a few questions, such as:
- Can I contribute to an IRA if I also contribute to a 401k or other company-sponsored retirement plan?
- Can I contribute to an IRA if I am over 72?
- When is the IRA contribution deadline?
- In what situations are IRA contributions non-deductible?
- Can I contribute to an IRA if I do not have any income?
- Can I contribute to a traditional IRA and a ROTH?
The answers to all of those questions and many more can be found on the IRAs and Qualified Plans Q&A page on my website. Check it out.
Send me a message or call if you have questions on today’s topic: firstname.lastname@example.org