Rules for Using Self-Employed Retirement Funds for Business Debt[yoast-breadcrumb]
Rules for Using Self-Employed Retirement Funds for Business Debt
Being your own boss has its perks. You get to set your own schedule, choose your clients, and make your own rules. But it also comes with challenges, like saving for retirement and managing business expenses. As a self-employed person, you have several options for retirement accounts that can also help you manage business debt. But there are important rules to follow so you don’t run afoul of the IRS.
Let’s break down the retirement plan options, the rules around using those funds for business expenses, and how to avoid penalties.
Retirement Plan Options for the Self-Employed
The most common retirement plans for self-employed folks are:
- SEP IRA
- SIMPLE IRA
- Solo 401(k)
- Traditional IRA
- Roth IRA
Each has its own contribution limits, tax benefits, and rules around accessing the funds. Let’s quickly summarize:
A SEP IRA allows you to contribute up to 25% of your net earnings from self-employment, up to $61,000 for 2023. Contributions are tax deductible and funds grow tax deferred. You can access funds at age 59 1/2 or for certain emergency expenses.
With a SIMPLE IRA, you can contribute up to $15,500 in 2023 if you’re under 50 or $20,500 if over 50. Like the SEP IRA, contributions are tax deductible and funds grow tax deferred. There is a 25% early withdrawal penalty if accessed before age 59 1/2.
A solo 401(k) has higher contribution limits than a SEP or SIMPLE IRA. In 2023, you can contribute up to $22,500 as an employee plus up to 25% of net earnings from self-employment as the employer, up to $66,000 total. Taxes are deferred until withdrawal.
You can contribute up to $6,500 to a traditional IRA in 2023 if under 50 or $7,500 if over 50. Contributions may be tax deductible depending on income. Assets grow tax deferred and withdrawals before 59 1/2 incur a penalty.
With a Roth IRA, you can contribute up to $6,500 in 2023 if under 50 or $7,500 if over 50. Contributions are not tax deductible but withdrawals in retirement are tax-free. As with the traditional IRA, early withdrawals incur a penalty.
Rules for Using Retirement Funds for Business Expenses
When it comes to using retirement funds for business expenses, the rules differ depending on the type of account.
You can take a loan from your SEP IRA, but it cannot exceed 50% of the account balance or $50,000, whichever is less. The loan terms must be at least 5 years, unless used for a primary home. Interest payments go back into your account. If you fail to repay in time, the outstanding balance is treated as an early withdrawal.
Loans are not allowed from SIMPLE IRAs. The only way to access funds early is by taking a distribution, which is subject to ordinary income taxes and a 25% early withdrawal penalty if under age 59 1/2.
You can borrow up to 50% of your solo 401(k) balance or $50,000, whichever is less. The loan terms must be 5 years or less, unless used for a primary home. If you fail to repay in time, the outstanding balance is treated as an early withdrawal subject to income tax and a 10% penalty if under 59 1/2.
You can take a loan from your traditional IRA, but it cannot exceed 50% of the account balance or $50,000, whichever is less. The loan terms must be 5 years or less, unless used for a primary home. Unpaid balances are treated as early withdrawals.
Unlike other retirement accounts, you cannot take a loan from a Roth IRA. The only option is to take an early withdrawal, which is subject to income taxes and a 10% early withdrawal penalty if under age 59 1/2.
When using retirement funds for business expenses, keep these tips in mind to avoid penalties:
- Take a loan rather than distribution whenever possible
- Limit loan amounts to 50% of the account balance or $50,000
- Make sure to repay loans within 5 years as required
- Be prepared to pay income tax plus a 10-25% early withdrawal penalty if under 59 1/2
- Rollover funds to avoid the early withdrawal penalty if under 59 1/2
- Consider the pros and cons carefully before accessing retirement funds early
Also keep in mind that if your business fails, you’ll still need retirement income down the road. It’s generally better to find other sources of financing for business expenses if possible.
The Bottom Line
Saving for retirement and running a business both require planning. While your retirement accounts can provide a source of financing in a pinch, take the time to understand the rules to avoid headaches. Retirement funds come with great tax benefits, so you don’t want to squander them unnecessarily. But if the need arises, loans from SEP, SIMPLE, solo 401(k) and traditional IRAs can provide access without penalty in many cases. Just be sure you have a solid repayment plan in place first.
Let me know if you have any other questions! I’m always happy to chat more about small business retirement plans and rules around using the funds.
All the best,