Retirement Strategies for Self-Employed Workers

Self-employment offers many perks, like a flexible schedule, diverse workload and the opportunity to choose only the assignments that interest you.

However, there are also downsides to being self-employed. One of the biggest hurdles people face when moving from a traditional job to self-employment is planning for retirement. It is easy to rely on your company’s pension plan or 401K with investment matching, especially with automatic payroll deductions.

Self-employment means you lose many of these popular retirement planning options. Instead, you must come up with a retirement plan on your own and carefully oversee it to make sure it accomplishes your financial goals. This means taking the time to understand the options and strategies available to you. Careful research and consultation with a financial advisor can help you determine a sound retirement strategy based on your self-employment and anticipated retirement needs.

A Taxable Account

The easiest way for you to save for retirement as a self-employed individual is to open up a taxable account at a bank or credit union. This can be a bank account, mutual fund or brokerage relationship depending on your preferences. Taxable accounts are the most flexible option because you can access the funds at any time, though you are required to pay taxes on the account each year. However, if you have shares of stock in a taxable account, any price gains over time are not taxed until you sell your shares. This deferral can save you some money up front.

Solo 401K

A Solo 401k is great option for self-employed business owners if they are able to invest a large portion of their income. In 2018, workers could put as much as $55,000 into a Solo 401K. If you are 50 years of age or older, you can contribute up to $61,000. Employers can contribute up to 25 percent in additional compensation as well.

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Solo 401ks are attractive for a variety of reasons. Self-employed individuals can contribute a generous portion of their earning each year, and the set-up fees are usually low or non-existent. Perhaps most important for the self-employed, contributions are optional. If you run into a few lean months with your business, you do not have to contribute anything to your 401K. Likewise, you can choose to increase your contributions when business is booming. You can also roll any previous 401Ks into your new solo account.

Traditional or Roth IRA

If your business is just starting up, or you do not yet have the funds to contribute more than $5,500, a traditional or Roth IRA is your best bet. Like a Solo 401k, you can roll any other 401Ks into your IRA. However, the maximum you can contribute each year is $5,500, or $6,500 if you are 50 years of age or older. Retirees can make tax-free withdrawals from the account. This is the easiest way for anyone who is self-employed to save for retirement, whether they have employees or not.

SEP IRA

If you are self-employed with few or no employees, a Simplified Employee Pension (SEP) IRA may be the right retirement plan for you. There are higher contribution limits on these, which allow high-income workers to contribute up to one-quarter of their compensation, with an annual cap of $55,000.

There is also a tax advantage with a SEP IRA. You can deduct either your total contributions, or 25 percent of your self-employment earnings, whichever is less. However, distributions are taxed as income when you retire. Keep in mind that calculating your net compensation can be complicated, as you have to take both your SEP IRA contribution and any self-employment tax payments into account.

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Additionally, if you are the employer you are required to contribute an equal percentage of salary for yourself and your employees. In other words, if you contribute 10 percent of your income, you must contribute 10 percent for each eligible employee.

SIMPLE IRA

The SIMPLE IRA stands for Savings Incentive Match Plan for Employee IRA. It allows you to save as much as $12,500 if you are less than 50 years of age, or $15,500 if you are 50 years of age or older. You can also match your own contributions up to three percent as an employer.

You can also opt for an alternative, non-matching two percent contribution, to a maximum of $5,500 each year. This is a good option for small businesses with employees who want to use a SIMPLE IRA.

Defined Benefit Plan

This retirement plan is similar to employee pension plans. It has a stated annual payout you receive when you retire, which is often based on how long you have worked, and your salary. Your age and expected returns on the plan’s investment also factor into your retirement payout. A defined benefit plan is a very attractive option for higher income, self-employed individuals, as the IRS allows maximum benefits up to $225,000 in 2019. In addition, this is a tax-deferred plan and you can write off the contributions as a business expense.

If you have employees, you must contribute on your employee’s behalf. As such, this is best for individuals who have only a few employees, or none at all. These plans are expensive to maintain and run. However, if your income is high, this may still be the best plan for you.

How to Choose the Right Self-Employment Retirement Plan

Choosing the right retirement plan is crucial to a happy, financially secure retirement. With this in mind, take the time to evaluate the various options, and talk to a financial planner before setting up your account. If maximizing your retirement savings is the most important goal, a Solo 401K is a good choice. It offers the benefit of both employee and employer contributions, making it a money maker for self-employed entrepreneurs with lots of income.

If you would rather have a retirement plan that is user-friendly and easy to set up, you can opt for a regular taxable account or IRA. You do not need to set up a retirement account that is focused on your business if you are only interested in your own retirement and you do not have employees. An accredited financial counselor can further help you define and personalize your strategy.

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