I’m Self-Employed. How Do I Save for Retirement?

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Retirement planning, like every other aspect of your business, assumes a new dimension when you’re self-employed. Many don’t have the luxury of employer-sponsored plans with cushy matches or intact pensions waiting to be tapped. When you work for yourself, saving for retirement falls entirely on your shoulders. 

Luckily, there are several ways to save proactively for your golden years. Let’s explore some common retirement savings vehicles that self-employed people can consider.

Rise in Self-Employment

Over 35% of the workforce are freelance professionals according to a study by the Freelancers Union and Upwork. The same study also revealed freelance income generates nearly $1 trillion dollars, further bolstering its importance to the U.S. economy.

While the pandemic has hit freelancers and contract workers hard, many experts still predict a rise in this type of work over the next few years. With our increasing reliance on technology, it’s easy to see how the gig-economy can thrive. What isn’t thriving? Freelancer’s retirement savings.

Drop in Retirement Savings

Time and again, sources confirm that saving for retirement is more difficult for the self-employed. The most recent report by Transamerica Center for Retirement Studies found that 15% of self-employed people aren’t saving anything for retirement and 37% have no retirement plan at all.

The group hit hardest? Single-person firms. Pew Charitable Trusts Research discovered only 13% of self-employed people in single-person firms are saving for retirement.

Why is Retirement Saving So Much Harder?

Several factors make retirement saving difficult for self-employed individuals:

  • Business expenses
  • Inconsistent income
  • Health insurance 
  • Cost of living
  • Debt
  • Other savings goals

For self-employed people, retirement planning can seem like a full DIY project. While building the right plan for your business does take time, diligence, and discipline, it’s infinitely worth the effort.  

Why Establish a Retirement Account?

Retirement savings is critical to help business owners:

  • Lower your taxable income with pre-tax contributions
  • Write off the plan administration (and your time working with it) as a business expense
  • Work toward financial independence and security for the future

Another reason to emphasize saving is that self-employed people usually find that they will receive less money from Social Security than people who worked for traditional employers at comparable income levels. Self-employed people tend to structure their businesses to minimize taxable income. While this makes sense for tax purposes, it has the unintended effect of lowering the amount of income that is reported to Social Security. 

Entrepreneurs have multiple priorities, but retirement savings shouldn’t be neglected. Make establishing the right savings plan for you a top priority. How? By reclaiming control over your retirement savings journey.

Top Retirement Savings Options for the Self-Employed

Several retirement avenues exist depending on your goals and the size of your business (i.e. revenue and number of employees). The most common options are:

  1. Traditional or Roth IRA
  2. Solo 401(k)
  3. SEP-IRA
  4. SIMPLE IRA

Let’s look at each plan to determine what they are, how they work, and which might be best for you. 

1. Traditional or Roth IRA

Self-employed people can supplement retirement savings by opening a traditional or Roth IRA, depending on your business and long-term goals. Since both accounts are individual plans, you have complete control over the financial institution that runs it and the flexibility of investment selections. 

Both traditional and Roth IRAs have the same contribution limits, $6,000 or $7,000 (if over 50 in 2021). The main difference is how they are taxed. With a traditional IRA, similar to the accounts above, contributions are made pre-tax, growth grows tax-free, and qualified distributions are taxed as ordinary income. 

A Roth IRA is essentially the opposite. Contributions are after-tax, growth is tax-deferred, and qualified distributions are tax-free. Roth IRA contributions do come with specific income thresholds but offer a great opportunity for tax-diversity in retirement. 

Finally, if you are leaving a current job to open your own business, you can roll over funds in your old 401(k) into an IRA.

2. Solo 401(k)

If you own your own business and have no employees (except your spouse), establishing a solo 401(k) could be a great fit. 

A solo 401(k) operates similarly to other 401(k) plans at larger companies, from pre-tax contributions (up to certain income levels) to total contribution limits, to early withdrawal penalties and more. Some Solo 401(k) plans have Roth 401(k) options, and they may also allow contributors to take out loans from their accounts. 

The key difference is a solo 401(k) lets you contribute both as an employee and an employer. This benefit provides extensive leeway for contributions and a significant advantage compared to other tax-advantaged retirement plans. 

  • Your employee contributions are considered elective deferrals, which you can max out at $19,500 or $26,000 (if over 50) 
  • The business can also contribute up to 25% of compensation (known as employer non-elective contributions)

2021 plan contribution thresholds are $58,000 or $64,000 for those over 50. If your spouse also works for the company, they can contribute up to those same limits and you can match their contributions.

What should you look for when establishing a solo 401(k)?

  • Wide variety of assets (mutual funds, ETFs, etc.)
  • Reasonable fees (administration, maintenance, etc.)
  • Reputable financial institution
  • The right amount of plan flexibility

3. SEP-IRA

A simplified employee pension (SEP) IRA is a good option for sole proprietors or business owners with just a few employees, particularly if those employees are not well-compensated and would not likely participate in a 401(k) program. SEP contributions are deductible for the business, and are not included in employee gross income.

SEP contributions can only be made by the employer, not the employees. This means if you have eligible employees on your team, you have to make contributions on their behalf at the same percentage you make to your own SEP, which can get expensive quickly.

Say you save 20% of your total compensation; with a SEP-IRA, you must also contribute 20% of your employee’s compensation to their plan. 

Here are some rules to consider:

  • You can contribute the lesser of 25% of total compensation or $58,000 in 2021
  • You can also fund up to 25% of compensation for each employee up to $290,000 in 2021
  • SEP-IRAs don’t allow catch-up contributions
  • SEP-IRAs don’t have a Roth equivalent

Another SEP-IRA benefit is you don’t have to commit to a certain contribution threshold each year—a great perk for those with varied incomes. 

A SEP-IRA is a variation of a traditional IRA and among the simplest plans to establish and run. Contributions are tax-deductible, funds grow tax-free, and distributions are taxed as ordinary income in retirement. 

4. SIMPLE-IRA

Are you looking for a plan suited for several employees? The SIMPLE-IRA (Savings Incentive Match Plan) could be a welcome fit for your company. This plan is best for businesses with up to 100 employees, allowing both the employer and employee to contribute to the account. 

Here are the basics: 

  • Employees can contribute up to $13,500 in 2021
  • Employers can choose a non-elective contribution of 2% of the employee’s salary or a 100% match on up to 3% of their salary
  • SIMPLE-IRAs offer catch-up contributions for those over 50—an extra $3,000 in 2021

This plan is solid for employers on several fronts. The start-up and maintenance fees are low and any contributions made to an employee’s account are tax-deductible. No discrimination testing is required. Thanks to the SECURE Act, employers that establish a plan with an automatic contribution are eligible for a maximum $500 tax credit, furthering the tax benefits of this account. 

While a SIMPLE-IRA offers many benefits, contribution thresholds are significantly lower than other vehicles, limiting the amount you and your employees can annually save for retirement.

How to Find the Right Retirement Plan for Your Small Business

Business owners have several options for retirement savings vehicles. While a busy entrepreneur’s time is often limited,, saving for the future must be a top priority for yourself and your business. 

The right retirement plan for your company will depend on revenue, employees, tax situation, and goals. At Abacus, we prize working with small business owners to help them find financial security, stability, and freedom. 

If you’d like to talk more about which retirement plan would suit your needs, talk to an Abacus advisor today

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