By Ian Berger, JD
As we move into 2022, small business owners may be wondering whether they still have time to establish a new retirement plan for 2021. The short answer is: “It depends.”
There are several retirement plan options especially designed for small business owners, including the self-employed. These include SEP IRAs, SIMPLE IRAs and Solo 401(k)s. All three can be opened up and maintained easily and inexpensively, and all allow tax-deductible contributions that can be significantly higher than the IRA contribution limit.
SEP IRAs. SEP IRAs give you the most flexibility. A new SEP can be set up and funded for a prior year. So, a new SEP for 2021 can be established as late as the deadline, with extensions, for the business’s 2021 tax return. Depending on the type of business, that can be as late as 9/15/22 or 10/15/22.
Solo 401(k)s. The rules for adopting a new solo 401(k) for a prior year are confusing. The SECURE Act includes a provision that allows extra time to set up new non-IRA based employer plans like 401(k) plans. The old rule was that such new plans had to be adopted by the last day of the employer’s tax year (typically 12/31). Now businesses have until the due date for the corporate tax return, including extensions, to put a new plan into place (just like new SEP IRAs).
However, that extended deadline only applies to solo 401(k) employer contributions – not to elective deferrals. The IRS says that a self-employed individual must make a 401(k) deferral election by the last day of the year. For a deferral election for 2021 to have been made by 12/31/21, a 2021 solo 401(k) plan offering elective deferrals had to be in place by that date.
That means it’s too late to adopt a solo 401(k) for 2021 if you wish to make elective deferrals. But it’s not too late if you limit your 2021 solo plan contribution to employer contributions. Since 2021 elective deferrals aren’t allowed, the maximum 2021 contribution for a new solo plan adopted in 2022 is $58,000. By contrast, if a new plan had been adopted in 2021, the contribution limit for owners over 50 would have been $64,500 if the $6,500 elective deferral catch-up contribution had been used.
SIMPLE IRAs. SIMPLE IRAs have the most restrictive rules. A new SIMPLE cannot be adopted for a prior year. Instead, it must be established by 10/1 of the year it becomes effective. This means a new SIMPLE IRA for 2021 had to be established by 10/1/21 and can’t be set up in 2022.