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Maximizing Retirement Savings: 401(k) Matching vs. Taxable Brokerage Accounts


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When it comes to saving for retirement as a business owner, especially one operating as an S Corporation, you've got several options at your disposal. However, choosing the right strategy can be a complex and pivotal decision with profound implications for your financial future. One of the most common dilemmas you might face is whether to utilize your Solo 401(k) plan to its fullest extent or consider alternative investment avenues, such as taxable brokerage accounts. To find the best approach for your unique circumstances, you'll need to consider your long-term goals, tax implications, and various other factors.

Before we delve into the specifics, it's crucial to highlight that individual financial situations can vary significantly, and seeking personalized advice from a qualified tax advisor is always a prudent step. They can provide tailored guidance based on your specific financial circumstances and the ever-evolving tax laws. Here, we will provide an overview of the key factors to consider when making this decision.

Understanding Solo 401(k) Plans

First, let's get acquainted with Solo 401(k) plans. These retirement accounts are specifically designed for self-employed individuals, such as sole proprietors, freelancers, and business owners. An S Corporation owner, like yourself, can also set up a Solo 401(k) plan. One of the significant advantages of a Solo 401(k) is the potential for significant tax benefits and the ability to contribute as both an employer and an employee.

As the only employee of your S Corporation, you have the unique privilege of contributing to your Solo 401(k) as both the employer and the employee. In 2022, the employee contribution limit for a Solo 401(k) is $20,500, with an additional $6,500 catch-up contribution for those aged 50 or older. However, the employer contribution can be up to 25% of your total compensation (your salary as an employee). This could potentially allow you to contribute more money to your retirement savings compared to other retirement plans.

The Employee Contribution Limit Dilemma

Now, let's address your specific question about the employee contribution limit. If your salary as an employee is higher than the $20,500 (or $27,000 with catch-up) employee contribution limit, you might feel like you're facing a dilemma. This is a common scenario for S Corporation owners who aim to optimize both tax savings and retirement savings.

One option is to maximize your employee contributions to your Solo 401(k) by contributing up to the limit. This ensures that you're making the most of your retirement account. However, it leaves a portion of your compensation that exceeds the limit subject to taxation without the tax-advantaged shelter of a retirement account.

Using Employer Matching to Contribute More

This is where the concept of using employer matching to contribute extra to your 401(k) comes into play. In your case, as the business owner, you can make employer contributions to your Solo 401(k) based on your net earnings from self-employment. This allows you to direct some of the earnings exceeding the employee contribution limit into the retirement account, effectively lowering your taxable income.

However, the decision to contribute as an employer should be calculated carefully. Employer contributions are typically a percentage of your net self-employment income, which can be up to 25%. These contributions can provide tax benefits, but they are subject to certain limitations and may vary depending on your specific financial situation.

Benefits of Contributing as an Employer

Here are some potential benefits of using employer contributions to your Solo 401(k):

  1. Tax Savings: Employer contributions are tax-deductible for the business, reducing your taxable income as an S Corporation owner. This can lead to a lower tax liability and more funds available for retirement savings.
  2. Compound Growth: Funds contributed as an employer will grow tax-deferred within the 401(k) until you start making withdrawals. The power of compounding can help your retirement savings grow over time.
  3. Maximized Retirement Savings: By utilizing both employee and employer contributions, you can contribute a more substantial amount to your retirement account, potentially accumulating a larger nest egg for the future.

Considerations and Trade-offs

While employer contributions offer distinct advantages, there are also important considerations and trade-offs to be aware of:

  1. Plan Complexity: Managing both employee and employer contributions to your Solo 401(k) can be administratively complex. You may need to engage a financial advisor or utilize specialized software to ensure compliance with IRS rules.
  2. Future Liquidity: Funds contributed as an employer are generally subject to the same withdrawal restrictions as those made as an employee. This means that you may not access these funds until retirement without incurring penalties.
  3. Diversification: Putting all your retirement savings in a single investment vehicle, such as a 401(k), may limit your diversification options. A taxable brokerage account can offer more investment flexibility.
  4. Future Tax Implications: While employer contributions offer tax benefits now, you may face taxes upon withdrawal during retirement. This tax treatment can vary based on your income and tax laws at that time.
  5. Risk Tolerance: Assess your risk tolerance, investment horizon, and retirement goals when deciding how much to contribute to your retirement accounts. Diversifying your investments across different types of accounts may align better with your overall financial strategy.

The Role of a Tax Advisor

Deciding whether to maximize contributions as an employer or rely on taxable brokerage accounts for additional retirement savings is a complex decision. The role of a qualified tax advisor is invaluable in this process. They can provide a personalized assessment of your financial situation, taking into account factors like your current income, future retirement goals, and the tax implications of each approach. Furthermore, they can help you navigate the ever-changing landscape of tax laws and ensure you are in compliance with IRS regulations.

In conclusion, as an S Corporation owner with a Solo 401(k) plan, your goal of paying as little tax as possible while saving for retirement is admirable and attainable. Both maximizing employee contributions and utilizing employer contributions have their advantages and drawbacks. The right approach for you depends on your unique financial circumstances and long-term goals. To make an informed decision, seek the counsel of a knowledgeable tax advisor who can guide you through this complex terrain and help you chart a course towards a financially secure retirement.