Retirement Savings Channels
I’m sure you have heard the saying if you love what you do, you’ll never work a day in your life.
This sentiment reflects the mindset of many people who have started their own businesses and are building a life on passion, determination, drive, and love.
Even though you love what you do, you may still want to retire at some point. Instead of having an employer/employee contribution plan, your retirement savings are completely up to you. This independence can leave many people unsure about how they can save for retirement. Retirement saving is not just for those working for a company, as a self-employed worker you also have many options for saving.
Solo 401 (k)
Let’s take a closer look at these options to help determine the best option for you.
Individual Retirement Accounts
Many self-employed people elect for contributing retirement money into an individual retirement account (IRA). An IRA is such a popular option due to its flexibility and separation from your business. These accounts rely on you as an individual contributing to the account which allows for deposits that fit into the ebbs and flows of the entrepreneurial lifestyle. Not all IRAs are built alike, each account is funded and taxed in different ways and it is important to understand the nuances in order to help you make the most of your savings.
A Traditional IRA is most similar to a workplace 401(k). The money is contributed and grows in the account on a pre-tax basis. This means that any money you contribute isn’t subject to income tax today, which could serve as a huge benefit come tax time.
You may contribute up to $5500 in a year to a Traditional IRA. One important caveat with this tax deduction is that it may be limited if you and/or your spouse is also contributing to a 401(k) or earn more than allowed.
Reducing your current taxable income is one of the main benefits of a traditional IRA. All of that money can’t stay tax-free forever, meaning that all withdrawals from the account must be claimed as taxable income. There are penalties for withdrawing before you turn 59 ½, and you absolutely must begin withdrawing at 70 ½. Understanding the tax parameters of this account will help you figure out if it is a good option for you.
A Roth IRA differs from a traditional IRA in one main form: taxes. Any money contributed to a Roth IRA is taxable income; therefore, you do not receive a tax break on the money you put in today. Since you paid taxes on the money when you made the contribution, you are not required to pay taxes on the money when you withdraw it.
You may also contribute up to $5500 to a Roth.* The income threshold is a bit more interesting. For those filing single in 2019, if your adjusted gross income exceeds $137,000 you cannot contribute to a Roth IRA at all. Joint filers in 2019 have to fall below $203,000 to contribute and their reduction in contribution allowances begins at $189,000.
* You may contribute to both a Traditional and Roth IRA, but for an aggregate of $5500, not $5500 to each.
A SEP IRA is connected to your business and allows you to contribute as a company as opposed to an individual. The big difference with a SEP IRA is that only the business is able to contribute to the account. Therefore, if you employ other people, you will need to contribute the same amount of money to their accounts as you do your own. This stipulation often gives people pause, especially if they employ a number of people. This account may be best suited for solopreneurs and people who are looking to contribute a large amount of their profit. You can contribute up to 25% or $55,000 (whichever is less) of your earnings. This is a much higher contribution threshold than a Traditional/Roth IRA which can help entrepreneurs who are a bit behind on saving or who want to get a great head start.
If you are a business that has grown from 2 employees to 20, a Simple IRA may be a great option for you. This account is designed for businesses that are a bit larger with more employees. You can contribute $12,500 each year to the plan, and if you also contribute to another employer’s retirement plan like a 401(k), you can’t contribute more than $18,500 total between the two.
The primary difference between a Simple IRA and SEP IRA is that employees can contribute to the plan. Though the employer does not have to shoulder all of the contributions, they are required to contribute 2% of their employees salary to the Simple IRA or match contributions up to 3%.
Simple IRAs are funded on a pre-tax basis for the employee and the employer, which can lead to tax deductions for both the employee and the business unit. Any distributions in retirement are taxed and the income limit for contributing in 2018 is $275,000.
Called the “one-participant 401(k)” by the IRS, this account is perfect for solopreneurs and their spouses. The account provides you with the flexibility to contribute more when business is going well and less when finances are tight. With a solo 401(k) you are both the employer and the employee.
Armed with your double identity, you are able to contribute up to $18,500 as the employee and an extra 25% of your compensation as the employer. If you are an LLC you are even able to contribute 25% of your net income.
Similar to a traditional 401(k) plan, the money you contribute is tax deductible and becomes taxed when you begin to withdraw money at your retirement age.
Understanding Your Choices
As you can see there are many options available to entrepreneurs of all types. Whether you employ 30 people or you fly solo, there is a retirement plan for you. Now is time for you to find it and start saving. I would love to help you find the best option for you and your business. Give me a call and I can help you reach your retirement savings goals.