If your income is lower than normal this year, you might not benefit as much from tax deductible retirement account contributions as you did last year when income was higher. Consider adding a Roth feature to your Individual 401(k) plan to add more flexibility to your tax planning and retirement savings. This flexibility is another reason why the Individual 401(k) plan is superior to the SEP-IRA.
An Individual 401(k) allows you to contribute up to $57,000 this year, and another $6,000 for a catch-up contribution if you’re over age 50. A combination of employee deferral and employer profit sharing will be needed to reach the maximum contribution. An employee may defer up to $19,500 to an Individual 401(k), plus a $6,000 catch-up if age 50 or older. The remaining $37,500 will be done as employer profit sharing.
While the employer profit sharing contribution will always be a pre-tax business expense, the employee contribution can be either pre-tax or post-tax, i.e. Roth. To make a Roth contribution to your Individual 401(k), a second financial account will be opened underneath the 401(k) plan. One account will be for Roth contributions and the other for regular pre-tax contributions.
There are several factors to consider when determining when and how much to contribute to a Roth. The main tradeoff between post-tax Roth contributions and regular pre-tax contributions is deciding when to pay your taxes, now or later. While many of us may think tax rates may only go up from here, that doesn’t mean they will go up for you.
If you have been able to accumulate assets in different account types with different tax consequences for withdrawals during retirement, then you’ve likely positioned yourself for more control over your income tax return in retirement. Having more control means you can manage which tax bracket you are in and very likely keep it lower than what you paid while working.
Although we do not know what the tax rates will be years from now, we do know the current 10% and 12% income tax brackets are historically low. These two lowest income tax brackets are also where many of our retired CRE brokers find themselves in retirement, especially before Required Minimum Distributions begin on pre-tax retirement accounts at age 72.
Currently, the 12% tax bracket ends at taxable income of $40,125 for a Single taxpayer and $80,250 for those Married Filing Jointly. Taxable income is determined after all tax deductions. Therefore, a broker earning nearly $150,000 can come very close to the 12% tax bracket limit after deductions. If you employ your spouse or have a Health Savings Account, the earnings could be even higher.
Once you have lowered taxable income to the 12% tax bracket, contributions to the 401(k) should be considered for Roth. Feel free to contact us to discuss how to lower your taxable income and determine if a Roth contribution is the right strategy for you.
