A unique Roth contribution opportunity for small business owners

As a small business owner, you may find yourself in a very unique situation to maximize your Roth savings. This is especially true if you are a sole proprietor business. Retirement plans fully covered by the Employee Retirement Income Security Act have additional complications that a third-party administrator (TPA) can help you manage.

The table below shows you many savings scenarios, but not all, depending on your marital status, age and whether you’ve phased out according to income. I will clarify the table columns related to row 2. You may need to scroll the table to see all the data. Employer Max refers to the fact that as an employer you can receive/save $66,000 in total contributions if you have qualifying income. You as an employee can set aside/save $22,500 in Roth 401(k) savings. That leaves $43,500 that you can add as an employer with qualifying income. Note that employer contributions are made before tax. Fifty Plus Savings indicates that since you’re over fifty, you can add $7,500 in catch-up savings to $22,500. No rollover to a Roth IRA. You can make too much money and gradually stop contributing. The 2023 income phase-out for single scope filers and heads of households is between $138,000 and $153,000 (married filing jointly, $218,000 to $228,000.)

Line 1 shows that in 2023, the Roth 401(k) allows you to make a Roth contribution of $22,500 if you earned more than $22,500 in income to account for state and federal withholding. While there is no income phaseout for a Roth 401(k), there is an income phaseout for a Roth IRA. If you’re under 50 and your modified adjusted gross income is less than $138,000, you can also make a Roth IRA contribution of $6,500. That’s a total of $29,000.

Line 2 shows that when you’re over fifty, you can add $7,500 to the standard Roth 401(k) contribution of $22,500 for a total of $30,000. You can also add $1,000 to Roth IRAs of $6,500 or $7,500. The amount amounts to $37,500.

Line 3 shows the possibility of under fifty, married filing jointly, MAGI under $218,000, assuming the spouse does not work in your business. The Roth 401(k) amount remains the same, but the Roth IRA option doubles to $13,000. That’s a total of $44,000 for the household.

Line 4 shows the same facts, but you are both over fifty. This adds an additional $2,000 opportunity. Now let’s see what happens if the spouse works in your business. That comes to a total of $45,000 for the household.

Line 5 shows the option for under fifty, married filing jointly. A Roth 401(k) allows your spouse to also make a Roth contribution of $22,500 if their income from your business is at least $22,500 to account for state and federal withholding. This increases the Roth 401(k) household savings to $45,000. For Roth IRA purposes, the modified adjusted gross income phase-out increases to $218,000. If you qualify, the Roth IRA opportunity doubles to $13,000.

Line 6 shows the same facts, but you are both over fifty. This adds an additional opportunity of $17,000, a $2,000 Roth IRA and a $15,000 Roth 401(k).

In a previous article, I explained that contributions to a profit-sharing 401(k) plan consist of employee deferral savings and employer contributions. Employer contributions can be seen as profit sharing. The maximum employer contribution is $66,000 for an individual. If your spouse is salaried, there is the potential for them to qualify for the same, doubling the household allowance to $132,000.

Do you really need to save that much? It depends on how much you want to live after retirement and how much you want to pass on to heirs. I recommend working with a credentialed financial advisor such as a Chartered Retirement Planning Counselor or Certified Financial Planner to help you customize your needs and do the calculations. You may have spent years trying to get the business off the ground and now you need to increase your retirement savings. As you can see, the Roth 401(k) itself offers a huge opportunity. Adding a Roth IRA offers even more opportunities to catch up.

A Roth 401(K) allows you to save $66,000 simply by using employer profit sharing. This means that all the money will be saved before taxes. That means you’ll face paying taxes on mandatory minimum distributions starting at age 72. Many people are surprised to learn that they either have to make withdrawals or how much those withdrawals will be taxed. Failure to withdraw the funds subjects you to a 50% penalty.

Through tax planning, you and a tax planning advisor may find some opportunities to help you qualify. For example, if you’re phasing out a Roth IRA, you may be able to reverse that by moving your 401(k) savings from a Roth to a traditional. This can enable your MAGI income by saving your employees’ pre-tax contributions. You can then convert this contribution in the future using a Roth Conversion. To learn more about Roth Conversions, click here.

It’s best to find a collaborative team of tax planning professionals, such as a CPA, enrolled agent, and certified financial planner, to find the right strategy for you. Tax saving strategies are much less risky than investing, with potentially much higher returns. We hope this information helps you maximize your Roth savings.

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