More and more people dream of starting their own business and working for themselves. Whether you’re just making the leap to self-employment or have been running a business for years, saving for retirement is frequently overlooked. In fact, one study showed that as few as 13% of self-employed individuals were contributing to a retirement account.
Just because you don’t have an employer-sponsored retirement plan doesn’t mean you can’t take advantage of other retirement accounts that can help you save for the future. Here, we’ll review a few of your options, as well as one underutilized strategy and how it stands out from the rest.
Your Many IRA Savings Options
As a self-employed professional, you have a number of options for saving for retirement, including several different individual retirement accounts. These include:
Personal retirement plans are another option for freelancers and business owners to use along with their 401(k). Three popular options are the Traditional, Roth, and SEP IRA. A Traditional IRA is similar to a 401(k) in that you can contribute pre-tax dollars to an investment account that grows tax-deferred. You can contribute up to $5,500, or if you’re over age 50, a total of $6,500.
With a Roth IRA, your contributions are not tax-deductible, like Traditional IRAs and 401(k)s. However, your earnings grow tax-deferred and your withdrawals are tax-exempt (subject to IRS guidelines). Like a Traditional IRA, you can contribute up to $5,500, or if you’re over age 50, a total of $6,500. However, one caveat to the Roth is that there are income restrictions. If you’re new in your career, you may be able to open a Roth IRA.
However, if your income surpasses the cutoff amount for a Roth IRA, you can still contribute to one through a backdoor Roth transaction. To do so, you contribute to a Traditional IRA and convert it to a Roth IRA.
A SEP IRA, also known as a Simplified Employee Pension, is an IRA similar to a Traditional IRA. As an employer of yourself, you can make contributions on your own behalf for your retirement. You can set up a SEP IRA in addition to a solo 401(k) and can contribute 25% of your self-employed income or $53,000 per year (whichever is the greater amount).
A myRA® is designed to make saving for retirement easy for those who don’t have access to a retirement savings plan at their job. Once you open an account, your money is invested in a U.S. Treasury savings bond. The interest rate is lower than many other investments (in 2016, it was less than 2%), but once you build up savings you can move on to other investments. It also features low fees and no penalties for early withdrawal.
Adding a Defined Benefits Plan
In order to save more than what your IRA limit you to, you can set up a defined benefit plan. These plans have much higher tax-advantaged contribution limits and can be designed to fit the needs of almost any business. Depending on your age and income, a defined benefit plan allows you to set aside up to hundreds of thousands of dollars to fund your retirement, making it possible to save a lot, even if you have little time.
The Lesser Known and Underutilized Strategy to Consider
Even if you’re using IRAs and a defined benefits plan, you might be missing out on a significant opportunity to save aggressively for retirement: using a one-participant 401(k), also known as a solo 401(k), Uni-K, or self-employed 401(k).
A solo 401(k) is similar to a traditional 401(k) you’d contribute to as an employee. Funds invested within a solo 401(k) plan grow on a tax deferred basis (meaning no capital gains taxes are due annually on any investment gains). The powerful feature of this plan is that you can contribute in two separate capacities—as an employee and as an employer. Wearing your “employee” hat, you can defer up to $18,000 (or $24,000 if age 50 or older). As the “employer,” you can also contribute up to 25% of compensation as defined by the plan.
Combined, you can contribute up to $54,000 if you’re over the age of 50! This is significantly more than you can contribute to IRA or defined benefits plan. If you’re in the 33%+ tax bracket, saving money for retirement before paying out taxes puts you in a great position to build wealth.
Ultimately, everyone’s situation is unique, so there’s no one answer I can give you on what accounts to utilize. However, for many people, it makes sense to contribute pre-tax and post-tax dollars to several different accounts. For example, along with a solo 401(k), you may also want to contribute to a Roth or SEP IRA.
Whatever You Do, Have a Plan
Whether retirement is one or five years away, it’s imperative you have a plan for your future and proactively save for retirement. There are a number of options for boosting your retirement savings as a self-employed professional or business owner, but the rules and specifics of each option can be complex and overwhelming. If you encounter questions as you investigate some of these retirement savings options, don’t hesitate to reach out to us. We’d be happy to help you review your options or offer guidance. Contact me at (626) 529-8347 or email me directly at [email protected].
Ricky Biel, CRPC® is a wealth manager with Haydel, Biel & Associates, an independent financial advisory firm serving individuals and families near Pasadena, California. The firm was founded in 2004 by Chris Haydel and Ricky Biel with a desire to provide unbiased, client-centered, community-based financial advice. Together, they have built a practice that has grown into a family of caring, smart professionals committed to blending proven investment methodologies with creative financial technologies that make it easier than ever to accomplish your goals. They strive to keep things simple and fun to give their clients peace of mind and alleviate financial stress. HBA Wealth takes care of their clients’ needs first and foremost and goes the extra mile to make their clients’ finances grow. To meet and see how the HBA Wealth team may be able to help, contact them today at (626) 529-8347 or email Ricky directly at [email protected].