I was asked by one of my readers to address this topic, and I think it’s an important issue that should be discussed. Being self-employed is a wonderful thing. You get to choose what hours you work, how to represent your own brand and have the final say on all of the decisions. But being self-employed is also a lot of hard work. I am still trying to figure out how to brand my business, and I have had the opportunity to experience what it will really take to run a successful business. Do I have everything figured out? Absolutely not!
When you are self-employed you don’t have access to things like company 401k plans, profit sharing plans, or corporate health care. So where, and how do you start to prepare for your financial future? You spend so much energy and work so hard. Why not have the dollars you are making today, work for you in the future? Here are 2 options that will help you save for retirement when you are working for yourself.
#1: Solo 401(k)
The great thing about a solo 401(k) is that you are the employer and the employee, which means you can contribute more to this type of retirement vehicle than you can to other options. There are two Solo (401K) plans to look at.
- Traditional 401(k): If you make contributions to this type of Solo 401(k), they will be made with pre-tax dollars. This means that no taxes will be taken out of the contribution amount that you put in. When you retire, and start taking distributions, taxes will need to be paid at that time.
- Roth Individual 401(k): If you don’t have a lot of self-employed income, you could use your low tax bracket to your advantage. With this type of Solo 401(k), taxes are taken out of the contribution amount you put in, and then they grow tax-free. If you are assuming that your business will grow, and your tax bracket will be higher in the future, this could save you some money. Since you already paid taxes when you made the contributions, all the funds you withdrawal in the future would be tax-free.
∗∗Note: These plans can only be opened and used if you are the only employee. One exception to this is your spouse. Your spouse can work in your business, and make contributions to the Solo 401(k) plan.
For more information (like contribution limits) on Solo 401(k) plans, and to see if they are right for you, check out IRS.gov.
#2: Simplified Employee Pension (SEP IRA)
To open this type of retirement savings plan only takes some basic paperwork, and requires no annual reporting to the IRS. You get the benefit of tax-deferred (you don’t have to pay taxes) contributions, and growth until you start taking distributions. As a general rule, you can start taking distributions from the account at age 59 1/2, but DON’T have to until you reach 70 1/2 years old. These plans really benefit self-employed workers who have very few employees or no employees. They also tend to have a higher contribution limit than the Solo 401(k) plans.
∗∗Note: Contributions can only come from the employer. If your business grows, and you end up hiring employees, you must include them ALL in the retirement plan. You must also remember, that you can’t contribute a higher amount to your account than you do for your employees.
For more information (like contribution limits) on SEP IRAs, and to see if they are right for you, check out Investopedia.com
Other Options For You To Explore:
- Defined Benefit Plan (Great for single employed workers who have a higher income)
- Savings Incentive Match Plan For Employees – SIMPLE IRA (Attractive for small business with lots of employees)
Saving for retirement if you are self-employed is not impossible. In fact, there are many great options out there for you choose from. You can reduce your taxable income, and enjoy the benefits of a lower tax bracket. You work hard, enjoy the benefits. Save yourself some money in the short term, and enjoy financial stability in the long term by putting your dollars to work today.
Always check with a financial advisor to see if you are making the absolute best choice. Know the rules, understand the contribution limits, and the tax implications.
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This is a great summary of the options! I’m not self-employed but my husband is and we were just talking about this last night. Now that his business is growing, it’s time for him to get some retirement savings in place. He does have 2 employees so I think we should rule out the SEP plan for now. Thanks for the tips!
Thanks for the comment Jenerra! Congrats on the growing business!