Starting a business often means wearing multiple hats and juggling immediate priorities, such as securing funding, building your product or service, and managing day-to-day operations. Retirement planning might seem like something to tackle later—when profits are rolling in. However, setting up a tax-advantaged retirement account early in your entrepreneurial journey can provide significant benefits, even before your startup becomes profitable.
This article explores options like SEP IRAs and Solo 401(k)s, tailored specifically for self-employed individuals and small business owners. Let’s dive into how these accounts work, their tax advantages, and why they’re worth considering even during your pre-profitability phase.
Why Retirement Planning Matters Early On
Many entrepreneurs delay retirement planning, assuming they need substantial profits to make contributions. However, starting early offers two major benefits:
- Compound Growth: Even modest contributions can grow significantly over time thanks to compounding interest.
- Tax Savings: Contributions to retirement accounts can lower your taxable income and may even offset self-employment tax liabilities.
These advantages can make a big difference in your financial future, even if your cash flow is tight during your startup’s early stages.
Tax-Advantaged Retirement Accounts for Entrepreneurs
1. SEP IRA (Simplified Employee Pension Individual Retirement Account)
- What It Is: A retirement account designed for self-employed individuals and small business owners.
- Key Benefits:
- Contributions are tax-deductible, reducing your taxable income.
- High contribution limits: Up to 25% of your net earnings from self-employment or $66,000 (for 2024), whichever is lower.
- Easy to set up and administer with minimal paperwork.
- Best For: Entrepreneurs with inconsistent income who want flexible contributions based on annual earnings.
2. Solo 401(k)
- What It Is: A 401(k) plan designed for sole proprietors and small businesses with no employees (other than a spouse).
- Key Benefits:
- Contributions can be made as both an employer and an employee, allowing for higher total contributions.
- Employee contributions of up to $22,500 (or $30,000 if you’re 50 or older) for 2024, plus up to 25% of net self-employment earnings as employer contributions.
- Option for Roth contributions, offering tax-free withdrawals in retirement.
- Loan provisions may allow you to borrow against your contributions if needed.
- Best For: Entrepreneurs seeking higher contribution limits and the ability to diversify their tax strategy with Roth options.
3. Traditional or Roth IRA
- What It Is: Individual retirement accounts available to anyone with earned income.
- Key Benefits:
- Contribution limits: $6,500 (or $7,500 if you’re 50 or older) for 2024.
- Roth IRAs allow for tax-free withdrawals in retirement.
- Traditional IRAs provide immediate tax deductions for eligible taxpayers.
- Best For: Entrepreneurs starting with lower contributions who want flexibility and a straightforward retirement savings option.
Funding Your Retirement Account Before Profitability
If your startup isn’t generating significant profits yet, you might wonder how to fund a retirement account. Here are a few strategies:
- Set Aside a Percentage of Side Income: If you have freelance work or other income streams, allocate a portion toward retirement savings.
- Start Small: Even small contributions can add up over time. Many accounts allow you to contribute as little as $50 to $100 to get started.
- Prioritize Tax Savings: Use tax deductions from retirement contributions to offset other self-employment taxes, effectively increasing your available cash.
- Leverage Startup Loans or Grants: While these funds are often earmarked for business expenses, optimizing your tax savings with retirement contributions can indirectly free up personal funds.
Additional Tax Benefits of Early Retirement Contributions
- Reduced Taxable Income: Contributions to SEP IRAs, Solo 401(k)s, or traditional IRAs reduce your adjusted gross income (AGI), which can lower your overall tax bill.
- Self-Employment Tax Mitigation: By reducing your net income, you may also lower the amount subject to self-employment taxes.
- Carry-Forward Benefits: If your contributions exceed your taxable income in a given year, you may be able to carry forward the excess and apply it in future years.
Planning for the Future: When Profitability Arrives
Once your startup turns a profit, having a retirement plan already in place simplifies scaling your contributions. You can:
- Increase your annual contributions to maximize tax savings.
- Expand to other plans, such as hiring employees and transitioning to a full 401(k) plan.
- Use your accumulated tax savings to reinvest in your business or diversify your personal investments.
Conclusion
Retirement planning doesn’t have to wait until your startup is profitable. SEP IRAs, Solo 401(k)s, and other tax-advantaged accounts offer entrepreneurs powerful tools to grow savings and reduce taxes—even during the early stages of their journey.
By taking small but intentional steps now, you’ll be setting yourself up for long-term financial security while also enjoying immediate tax benefits. For more guidance tailored to your entrepreneurial journey, speak to an ACGDEPT financial expert today.
