4 Reasons to Open a 401(k) Before the End of the Year

Siân Killingsworth / 23 Sep 2022 / 401(k) Plan Information

With the end of the year fast approaching, many small business owners are looking for tax savings. December is not too late to open a new 401(k) account, convert to a new retirement account type, or make contributions. Depending on your situation, you may have more time than you think to plan the ideal tax scenario for 2022.

If you’ve put off thinking about your retirement until the end of the year, here are a few reasons to act now:

ONE: Generous contribution allowances will help you save for retirement

A 401(k) account offers much higher contribution limits than most IRAs : some of which max out at just $6,000. SEP IRAs do not allow employee contributions, so you may not be able to save as much as you’d like. In 2022, the annual 401(k) limit is $20,500 for employees or $61,000 for employer/employee totals, plus an additional $6,500 if you’re age 50 or older.

TWO: You’ll start compounding interest sooner rather than later

When you invest in a 401(k), the money you add generates interest. This interest compounds year after year, as you earn interest on your interest.

Here’s an example. Let’s assume a very modest ability to save and a so-so economy returning just 5 percent. If you were to put in $5,000 this month and contribute just $100/month to your 401(k), in 30 years’ time you could have $105,924 saved for retirement.

On the other hand, say you put in the maximum of $61,000 today and contribute at least that much every year for 30 years. You’d be sitting on $4.2 million or more for retirement.

THREE: You had a particularly profitable year

Some 401(k) plans allow you to make a year-end contribution deposit directly into your account to reduce how much tax you owe for 2022. That can really boost your retirement savings without cutting into your regular paychecks.

FOUR: You want to get on track for next year

Opening a 401(k) now will help you attain your New Year’s resolution to save more for retirement in 2023. Establishing an account with a generous contribution level is one of the best ways to achieve a comfortable future. If you want to hit the maximum for 2023, you can save up to $1,708.33 per month (for an annual total of $20,500). If you’re age 50 or older, you can put in an extra $541.66 a month ($6,500 total). If you are self-employed, you can contribute as both employee and employer up to a maximum of $61,000 a year, plus the contribution for those age 50 or older.

The deadline is coming up

If you are self-employed with no full-time regular employees working for you (with the exception of a spouse), then you could qualify for tremendous tax savings with a Solo 401(k) account. You will be able to contribute as both employer and employee.

This means you can deposit a maximum of $61,000 (plus $6,500 more if you are over 50 years old) for yourself, which will then reduce your taxable income for 2022. You can also add your spouse to double your household savings if your spouse is not covered by another plan.

All you have to do is sign the Solo 401(k) adoption documents by December 31, 2022, and you will have until your tax return due date (April 17, 2023) to make the contributions for 2022. It is possible to apply for extensions to have until October 17.

If you’ve had a very lucrative year, you can also concurrently contribute money each month to put toward your 2023 return. If not, you can always take your time and save for the upcoming year well into 2024 in the same fashion, filing for tax return extensions if necessary.

The deadline for opening a traditional 401(k) plan is later!

The SECURE Act brought good news for employers: an extended deadline for adopting a new traditional 401(k) plan! You used to have until December 31, but now you have until the tax return deadline, including extensions. Here’s what those 401(k) contribution deadlines look like for the 2022 tax year:

• 12/2/22: Convert a traditional 401(k) into a Safe Harbor for 2022 with 3% nonelective contribution
• 3/15/23: Adopt a 2022 traditional 401(k) plan if you are taxed as a Partnership or S-Corp
• 4/17/23: Adopt a 2022 traditional 401(k) plan if you are a Sole Proprietorship or C-Corp
• 9/15/23: Adopt a 2022 traditional 401(k) if you filed an extension as a Partnership or S-Corp
• 10/16/23: Adopt a 2022 traditional 401(k) if you filed an extension as a Sole Proprietorship or C-Corp
• 12/31/23: Convert a traditional 401(k) plan into a 4% nonelective Safe Harbor plan for 2022
• Employees do not have more time to make salary deferrals, but employers have more time to decide whether they want to make a year-end profit-sharing contribution. Adding a Safe Harbor amendment to your plan is a great option if you worry you might not pass nondiscrimination tests for the year. Fortunately, you have plenty of time to make this decision.

Planning for the 2023 Plan Year

Now is also a good time to plan for the 2023 tax year using the following deadlines:

• 11/2/22: Notify SIMPLE IRA participants that their plan will convert to a new 401(k) plan on 1/1/23
• 12/2/22: Notify participants that the traditional 401(k) will convert to a matched Safe Harbor in 2023
• 12/31/22: Plan your conversion of an existing 401(k) to a match-based Safe Harbor for 2023
• 10/1/23: Adopt a new Safe Harbor 401(k) plan for 2023
• 12/2/23: Convert a traditional 401(k) plan to a 3% nonelective Safe Harbor for 2023
• 3/15/24: Start a new traditional 401(k) for 2023 if you’re an S-Corp or Partnership
• 4/15/24: Start a new traditional 401(k) for 2023 if you’re a C-Corp or Sole Proprietorship
• 9/15/24: Start a new traditional 401(k) for 2023 if you’re an S-Corp or Partnership with an extension
• 10/15/24: Start a new traditional 401(k) for 2023 if you’re a C-Corp or Sole Proprietor with extension

If you have any questions about setting up a small business 401(k), contact Ubiquity to administer the plan.