It’s the end of the year, and before time runs out, we have a few steps you can take to save money. If you don’t have a retirement plan or were thinking of setting one up, this article is for you. Remember, you’ll have to act fast since the end of 2022 is right around the corner.
Here’s what we’re going over:
- Establish your Retirement plan (before December 31st)
- Retirement Plan Start-Up Tax Credits
- Convert to a Roth IRA
Establishing Your 2022 Retirement Plan
Does your company already have a retirement plan? If not, and you have some money you can save, hurry up and set up your 2022 Retirement Plan before the year ends.
The most common retirement plan you’ve heard of is a 401(k). This is the most popular retirement plan for business owners. You can put away a lot of money and pay less tax. The cost of setting up 401(k)s have come down over the years, making them affordable to set up. Unlike Traditional and Roth IRAs, they have two types of contribution, so you can put away even more money. The types of contributions are:
- Employee Contributions: contributions from the employee’s own paycheck
- Employer Contributions: contributions made by the company, often referred to as the 401(k) Profit-Share, or 401(k) Match.
In 2022 the maximum deductions are for funding retirement plans like a 401(k) is $61,000. This number is indexed for inflation, so every year you can put away more. You also don’t have to have a big company to set one of these up. If you’re a single (or a married couple), with no employees, you can set up a solo 401(k) to save.
Here’s an example: Let’s say you own an S-Corporation, and you are the only employee of the company. You want an individual 401(k) deduction. You must have your 401(k) established before the end of the year. Once you have this in place, you can make your personal employee contributions before the end of 2022, and the employer contributions before you file the tax return and still have them count for 2022 (i.e., far out as October 15th, 2023.)
You can learn more about the different 401(k)s here:
Retirement Plan Start-Up Tax Credits
If you have employees (other than yourself) and you don’t have a retirement plan for your company set up yet, you may qualify for a tax credit of $15,000 over three years.
This tax credit was created from the SECURE Act in 2019. It is based on “qualified start-up costs” which are costs of establishing an employer retirement plan or costs of educating your employees about your retirement plan.
How Do I Qualify to Save Money?
Like anything with the IRS, there are rules you need to follow to qualify:
- You must have less than 100 employees in the previous year
- Employees must’ve been paid at least $5,000
- You cannot have had any other retirement plan in place in the prior 3 years
How Much Money Can I Save?
You can save anywhere from $500 to $5,000 per year, for up to 3 years. But it depends on the number of qualified employees you have. A qualified employee is somebody that makes over $5,000 a year, but less than $135,000 in 2022 ($150,000 in 2023). In other words, if you pay your employees too much or too little, they don’t help you qualify for the credit.
Automatic Enrollment Credit
You may also qualify for the Automatic Enrollment Credit.
When you set up your retirement plan and qualify for Retirement Plan Start-Up Tax Credit, if you add an auto-enrollment feature to your plan, you can receive up to an additional $500 tax credit per year, up to three years ($1,500 in savings.)
Keep in mind, you don’t qualify for either the Retirement Plan Start-up Tax Credit or Auto Enrollment Credit if you are the only employee of your company. In other words, you must be employing others to qualify.
Converting to a Roth IRA
Based on your income in 2022, you may want to consider converting your 401(k) or Traditional IRA to a Roth IRA.
A quick recap on how Traditional IRAs, 401(k)s, and Roth IRAs. With Traditional IRAs and 401(k)s you get a deduction when you put the money in the retirement plan but only pay tax on it (plus the growth) when you take it out.
Roth IRAs you don’t get a deduction when you put the money in, but you pay no tax on it or the growth when you take it out. Here’s a simple chart:
|Type of Retirement plan
|Deduction or Not
|When you pay tax
|Traditional IRA / 401(k)
|Deduction when you contribute
|Pay tax when you take money out
|No deduction when you contribute
|No tax when you take money out
The first thing you should know is that when you convert your Traditional IRA or 401(k) to a Roth IRA you pay tax on the entire conversion. So, before converting anything into a Roth IRA you need to weigh the pros and cons.
Pros of Converting to a Roth IRA:
- There are no requirement minimum distributions (RMDs) requirements for Roth IRAs (an RMD is when the government makes you take money out of your retirement account when you’re older than 72)
- Current tax rates are lower, due to Trump’s Tax Reform from 2017 (they are sent to expire in 2024 & 2025.) So even though you are paying tax on the conversion now, it would potentially be at a lower tax rate than in the future
- Due to terrible stock market decline in 2022, your taxable conversion may be less now than in later years.
Cons of Converting to a Roth IRA:
- You will have to pay tax on any amount you convert to a Roth IRA.
- Once you’ve converted your money into a Roth IRA, you must wait 5 years after the conversion to access your money, penalty free.
- Converting your money into a Roth IRA may push you into a higher tax bracket.
Roth IRA conversions are very, very technical, so we advise you to talk to both your CPA and financial planner before making this conversion (in fact, make sure they both talk to each other first.)
Setting up retirement plans are a good money strategy for most business owners, since it forces you to save and avoid paying the IRS at the same time. As mentioned, if you haven’t set one up before, this may be a good time to start. If you have employees and are thinking of setting one up for the tax credits, make sure to reach out to a CPA or tax professional to make sure you qualify.