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Ask Bob: Can I Invest Money From a Small Business in a Solo 401(k) While I’m on Social Security?

Taxpayers can make contributions to a solo 401(k) that they have established and maintain for the business, and an IRA, as long as they have income from their business, says Denise Appleby, CEO of Appleby Retirement Consulting.

Question

If I am collecting Social Security and I have a small business that doesn’t make much income. Can I still invest the money I am making from that business in a solo 401k or IRA I already have? Is the contribution I make still a tax deduction? How does Social Security view contributions to these investments when filing taxes? Are you no longer able to make contributions to these?

Everything written concerning Social Security deals with taking money out of 401k and IRAs not putting it in.

This conversation is coming up a lot given the environment we are in now. People are nervous about the out-of-control spending and are worried they may not have enough for retirement.

Answer

Yes, you can make contributions to a 401(k) that you establish and maintain for the business, and an IRA, as long as you have income from your business, according to Denise Appleby, CEO of Appleby Retirement Consulting. “Be careful here,” she explains, “as there are many factors that must be taken into consideration when you make contributions to a 401(k) for your business.”

Those factors include, but are not limited to:

a. Your amount of eligible income. Consult with your CPA to determine the amount of business income that can be considered for purposes of computing how much you can contribute to your 401(k)

b. Whether a 401(k) is the ideal plan for you. Your CPA can help you with this as well. And,

c. Whether you have ownership in other businesses and if so, whether the 401(k) would need to cover employees of those businesses

For the IRA: if the IRA is a traditional IRA, you can make the contribution as long as you have eligible compensation. Your contribution is capped at the lesser of $7,000 or 100% of your eligible compensation. Eligible compensation would include income you make from your business. If the IRA is a Roth IRA, you would be eligible to make the contribution only if your modified adjusted gross income (MAGI, does not exceed certain amounts based on your tax filing status. Your CPA can help you to determine whether you meet the income requirements.

For the second part of the question: Is the contribution I make still a tax deduction? Appleby explains that employer contributions made to your 401(k) would be deductible, as long as they are within the deductible limit. That limit is 25% of W-2 wages or 20% of modified net profit for unincorporated businesses.

“For traditional IRA contributions, you would be eligible to claim a deduction for the amount you are eligible to contribute if you are not covered under an employer plan and are not married to someone who is,” said Appleby. “Otherwise, your eligibility to claim a deduction depends on your MAGI and tax filing status.”

The limits can be explained in this chart Appleby provided.

MAGI limits for deducting contributions to traditional IRAs

Where is the chart?

Heather Schrieber, the founder of HLS Retirement Consulting, joins in to say, a small business owner would be wise to consider using the earnings from that business to save for their own retirement.

“Caution should be taken, however, as there are limits to both the amount that may be contributed to a company-sponsored retirement plan such as a Solo 401(k) and the type of income that may be used on which to determine the maximum contribution.”

Only earned income, not passive income, may be used to determine the amount you may contribute to your plan for your small business. The same is true for IRA contributions. You must earn at least $6,000 ($7,000 if age 50 or older) to make the maximum IRA contribution, whether it be a Traditional IRA, a Roth IRA, or a combination of the two, according to Schrieber.

While any monies you defer into your solo 401(k) plan are exempt from federal income tax, you might be surprised to learn that your elective deferrals are subject to social security (FICA) and Medicare taxes. Schrieber posed the example of: imagine you defer $10,000 of your $50,000 annual earnings into your solo 401(k). That would mean that you would pay income taxes on only $40,000; however, your gross earnings of $50,000 will be subject to social security and Medicare taxes. Any employer contributions you made such as a matching contribution or profit-sharing contribution would be a deduction for your business.

“The ability to contribute to a small business retirement plan is simply a function of whether you have earned income through your business,” said Schrieber. “Understanding that your gross earnings will be subject to social security and Medicare taxes, up to a maximum of $142,800 for 2021, is the extent to which you need to be concerned about the interaction between social security and your earnings. Further, even at the point at which you claim social security benefits and continue to work, your earned income will still be subject to both social security and Medicare taxes.”

Got questions? Get answers!

Email Robert.Powell@maven.io

Question

If I am collecting Social Security and I have a small business that doesn’t make much income. Can I still invest the money I am making from that business in a solo 401k or IRA I already have? Is the contribution I make still a tax deduction? How does Social Security view contributions to these investments when filing taxes? Are you no longer able to make contributions to these?

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