Retirement savings opportunities for independent workers and small-business owners were supposed to expand this year under a new law, but the Internal Revenue Service has yet to issue guidelines.
The Secure Act 2.0, passed in late 2022, authorized new Roth versions of SEP and Simple individual retirement accounts—key retirement savings vehicles for those setting up their own retirement plan.
While self-employed taxpayers have a green light legally to use a SEP Roth IRA or Simple Roth IRA, “you’ll be hard-pressed to find a custodian to set one up,” says Mark Luscombe, a principal analyst at Wolters Kluwer.
Like a regular IRA, traditional SEP and Simple IRAs allow investments to grow tax-deferred. When assets are withdrawn, they are included in your taxable income and subject to income-tax rates.
Contributions to these accounts by a sole practitioner or business owner are tax-deductible. With the Roth versions of both accounts, you make after-tax contributions that aren’t deductible, but assets in the account grow tax-free.
You can come out ahead by paying taxes now, instead of in retirement, if you expect to be in a higher tax bracket when you retire and begin pulling money out, or if you have a long enough investment timeline for growth to offset the taxes.
For any new tax rule passed by Congress, it’s standard for the IRS to issue guidelines on how to comply if details aren’t spelled out in the legislation. In many cases when there is a lag between the passage of legislation and IRS guidance, taxpayers and accountants can take advantage of new provisions while awaiting clarification.
But financial service firms must have the systems and procedures in place to accommodate taxpayers’ requests for a SEP or Simple Roth IRAs, and these highly regulated businesses are reluctant or unable to move forward without explicit IRS instructions.
“The industry is still waiting,” says Hibah Shariff, director of investor communications at
Charles Schwab.
“We will be building both the Roth SEP IRA and Roth Simple IRA once the guidance is provided by the IRS.”
When asked this week, the IRS was unable to provide information about the timing of its guidance.
A key advantage of these new Roth variations, once available, is that they will provide more options for sole practitioners and small-business owners to diversify their retirement income from a tax standpoint, says Nicole Birkett-Brunkhorst, a senior wealth planner at U.S. Bank Private Wealth Management.
“It’s important to emphasize building out tax-diversified streams of income that can weather future tax changes,” Birkett-Brunkhorst says. “The Roth piece can add an additional stream of tax-free income.”
Currently, independent workers have the option to create a Roth version of a solo 401(k). These accounts operate like a regular employer-sponsored 401(k).
While they are a solid option, you cannot have a solo 401(k) if you have any non-spouse employees.
For independent workers who have employees or may hire in the future, the Simple or SEP Roth IRA may be a better choice, says Birkett-Brunkhorst.
That is, once you can find a custodian to open one.
The good news is that the door doesn’t slam shut on a 2023 contribution to a Roth SEP or Roth Simple IRA until April 15, 2024. As with any IRA, contributions for any calendar year can be made up the April tax-filing deadline for that year’s tax return.
So there may still be time to take advantage of these accounts for 2023 if the IRS issues guidance early next year and financial institutions create the forms and procedures to set one up before the tax-filing deadline.
But the solo regular and Roth 401(k) contribution deadline is year-end, so it may be best to make a decision about where to save before these options expire for 2023.
Here are further details of current options:
Simple IRAs
Typically small-business owners with a number of employees favor Simple IRAs over SEP IRAs.
Simple IRAs are available to businesses with no more than 100 employees who have earned more than $5,000 in the preceding year, and operate similar to a 401(k). While business owners make after-tax tax-deductible contributions, their employees make pretax contributions.
Owners must make contributions for their employees up to specified limits—either a matching contribution of up to 3% of the worker’s compensation, or 2% of compensation if the worker doesn’t make a contribution.
The maximum contribution to Simple IRAs for 2023 is $15,500 or $19,000 for folks aged 50 or older. In 2024, those limits rise to $16,000 and $19,500 for older savers.
If you have an employer plan along with a Simple IRA, your total maximum annual contributions cap out at $22,500 this year and $23,000 in 2024.
SEP IRAs
Independent workers with no employees typically choose a SEP IRA. That’s because if you contribute to a SEP and have employees, you must make the same percentage-of-salary contribution for each employee that you make for yourself. That gets expensive for a business owner.
The maximum annual contribution to a SEP is the lesser of $66,000 or 25% of compensation for 2023. For 2024, the dollar cap rises to $69,000.
Solo 401(k)s and Solo Roth 401(k)
Just as with an employer-sponsored 401(k), solo 401(k)s allow pretax contributions and grow assets tax deferred, with income-tax rate applying to withdrawals.
The maximum contribution for 2023 is $61,000 or $67,500 for folks aged 50 or over. In 2024, the limits rise to $66,000 and $73,500.
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