Why Should I Open a 401(k) Before the End of the Year?

Author: Siân Killingsworth / 5 Dec 2020 / Business

With the end of the year fast approaching, many small business owners, independent contractors, and real estate investors 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 your contributions. Depending on your situation, you may have more time than you think to plan the ideal tax scenario for 2020.

Contact Ubiquity for assistance with setup and ongoing administration. We cater to small businesses and self-employed individuals with flat-fee plans that meet your business needs and your budget.

Reasons to open a 401(k) before the end of the year

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

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 $6,000. SEP IRAs do not allow employee contributions, so you may not be able to save as much as you’d like. In 2020, the annual 401(k) limit is $19,500 for employees or $57,000 for employer/employee totals, plus an additional $6,000 if you’re over 50. Next year, the employee maximum will stay the same, but this amount will increase to $58,000 total and $6,500 for the catchup contribution.

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 not-so-fantastic 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 $57,000 today and contribute at least that much every year for 30 years. You’d be sitting on $4.2 million or more for retirement.

You had a particularly profitable year.

Some 401(k) plans allow you to make a year-end bonus deposit directly into your account to reduce how much taxes you owe for 2020 AND boost your retirement savings without cutting deep into your regular paychecks.

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 2021. 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 2021, you can save up to $1,625 per month (for an annual total of $19,500). If you’re over 50, 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 to a maximum of $57,000 a year, plus the over-50 contribution.

The deadline to establish a new Solo 401(k) account is December 31, 2020.

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 $56,000 (plus $6,000 more if you are over 50 years old) for yourself – which will then reduce your taxable income for 2020. 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, 2020, and you will have until your tax return due date (April 15, 2021) to make the contributions for 2020. It is possible to apply for extensions to have until July 15 or even October 15.

If you’ve had a very lucrative year, you can also concurrently contribute money each month to put toward your 2021 return. If not, you can always take your time and save for the upcoming year well into 2022 in the same fashion, filing for tax return extensions if necessary.

Employers can adopt a new 401(k) plan by December 31, 2020 – or wait even longer!

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 2020 Tax Year:

• 12/2/20 – Convert a Traditional 401(k) into a Safe Harbor for 2020 with 3% nonelective contribution.
• 3/15/21 – Adopt a 2020 Traditional 401(k) plan if you are taxed as a Partnership or S-Corp.
• 4/15/21 – Adopt a 2020 Traditional 401(k) plan if you are a Sole Proprietorship or C-Corp.
• 9/15/21 – Adopt a 2020 Traditional 401(k) if you filed an extension as a Partnership or S-Corp.
• 10/15/21 – Adopt a 2020 Traditional 401(k) if you filed an extension as a Sole Proprietorship or C-Corp.
• 12/31/21 – Convert a Traditional 401(k) plan into a 4% nonelective safe harbor plan for 2020.

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 2021 Plan Year

Now is also a good time to plan for the 2021 tax year using the following deadlines:

• 11/2/20 – Notify SIMPLE IRA participants that their plan will convert to a new 401(k) plan on 1/1/21.
• 12/2/20 – Notify participants that the Traditional 401(k) will convert to a matched Safe Harbor in 2021.
• 12/31/20 – Plan your conversion of an existing 401(k) to a match-based Safe Harbor for 2021.
• 10/1/21 – Adopt a new Safe Harbor 401(k) plan for 2021.
• 12/2/21 – Convert a Traditional 401(k) plan to a 3% nonelective Safe Harbor for 2021.
• 3/15/22 – Start a new Traditional 401(k) for 2021 if you’re an S-Corp or Partnership.
• 4/15/22 – Start a new Traditional 401(k) for 2021 if you’re a C-Corp or Sole Proprietorship.
• 9/15/22 – Start a new Traditional 401(k) for 2021 if you’re an S-Corp or Partnership with an extension.
• 10/15/22 – Start a new Traditional 401(k) for 2021 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.