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There's Still Time to Start a Retirement Plan, Reduce 2021 Taxes

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What You Need to Know

  • The deadline to contribute to an IRA for any given year is the federal tax filing deadline for that year.
  • Under the Secure Act, small-business clients now have extra time to establish a 401(k) plan for the prior tax year.
  • Clients who contribute to their own SEP account must also contribute to the accounts of all employees for that year.

Now that we’re well into 2022, many clients have started to assess their tax picture more carefully for the 2021 tax year. For many small-business clients, the most pressing question may be whether they have any retirement planning options that could help reduce taxable income for the 2021 year.

Small-business clients generally have multiple retirement planning options — and, for some, it may be possible to establish the retirement plan even though 2021 is behind us. It’s important to play close attention to the details, however. Remember: While some retirement plan options remain, the deadline for others has already passed — and it remains important to evaluate each business’s situation before adopting a plan that could have lasting future implications.

Retirement Planning Options: Timeline for Establishing a Plan

As most clients know, the deadline to contribute to an IRA for any given year is actually the federal tax filing deadline for that year (this year, the federal tax filing deadline is April 18, 2022 for most taxpayers). Taxpayers can also take advantage of extensions — giving most clients until Oct. 15 to establish or fund the account. 

On the other hand, self-employed taxpayers must make elective deferrals to 401(k)s by the last day of the plan year (Dec. 31, 2021). Under a new rule created by the Secure Act, however, small-business clients now have extra time to establish a 401(k) plan for the prior tax year. Those clients now remain eligible to open a solo 401(k) and make employer contributions only  for the 2021 tax year (so, the client can contribute up to $58,000 in employer contributions for 2021). 

SEP IRAs are subject to the same deadline as traditional IRAs — meaning that the deadline is the business’s federal tax filing deadline (with extensions) and the client still has time to open and fund a SEP IRA for 2021. With extensions, the client could have until Sept. 15 or Oct. 15, 2022 to open the SEP IRA.

The deadline for establishing a SIMPLE IRA, however, is much earlier. Small-business clients had only until Oct. 1, 2021 (Oct. 1 of the year the plan became effective) to establish a SIMPLE plan for the 2021 tax year. 

Evaluating the Options

SEP IRAs are retirement planning vehicles that allow only the employer to make contributions on behalf of employees. In cases where the client is operating the business, the client is usually both employer and employee. Like other traditional retirement accounts, SEP IRAs are funded on a pretax basis (i.e., they are deductible by the client and reduce taxable income). 

For 2021, clients can contribute the lesser of (1) 25% of compensation or (2) $58,000 to a SEP IRA (increasing to $61,000 for 2022). Because the client often does not know how much compensation they have earned from the business until after the end of the calendar year, the ability to make contributions after Dec. 31 can help the client avoid overfunding.

The SEP IRA option may also be attractive because there is no requirement that the client contribute to the account every year.

It’s also important to remember how the presence of employees will affect the client’s retirement planning options. Sponsors of solo 401(k)s are not permitted to have any employees. Thus, business owners who plan to hire employees will no longer qualify for the solo 401(k) structure — meaning that they’ll be subject to the traditional nondiscrimination requirements that apply generally to 401(k) plans unless they satisfy certain safe harbor criteria.

Clients who do have employees should also know that, if they contribute to their own SEP account in any given year, they must also contribute to the accounts of all employees for that year.

Conclusion

For many clients, it’s not too late to establish a retirement plan for the 2021 tax year. In fact, now could be the ideal time for clients to evaluate their 2021 income planning needs and retroactively adopt a plan to reduce taxable income.


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