The joys of self-employment are many, but there are also stresses. High among them is the need to plan for retirement completely on their own. You are in charge of creating a satisfactory quality of life post-retirement. When it comes to building that life, the sooner you start, the better. Fortunately, there are many retirement plans for the self-employed.
- For self-employed workers, setting up a retirement plan is a task in itself.
- There are four available plans designed for the self-employed: one-participant 401(k), SEP IRA, SIMPLE IRA, and Keogh plan.
- Health savings plans (HSAs) and traditional and Roth IRAs are two more complementary options.
increase in self employment
A 2019 study conducted by the Freelancers Union and Upwork estimated that there are 57 million freelancers in the US, up from the 53 million reported in 2014. As per the report, it represents 35% of the entire workforce of the country. In 2020, the percentage of freelancing at any point in the year increased from 35% to 36%.
While this entrepreneurial spirit is to be commended, less appreciative is the fact that 30% of the self-employed sporadically save for retirement while 15% are not even saving. This is a problem. If you’re self-employed, you’re busy but retirement savings should be a priority.
Why Saving for the Self-Employed Is Hard
Not saving for retirement will come as no surprise to any self-employed person. The most common include:
- lack of stable income
- repayment of major debts
- health care expenses
- education expenses
- business running cost
Establishing a retirement plan is a task in itself, just like anything an entrepreneur does. No human resources (HR) employee is going to walk you through a company-sponsored 401(k) plan application. There are no matching contributions, no shares of company stock, and no automatic payroll deduction.
You have to be highly disciplined in contributing to the plan and, because the amount you can put into your retirement accounts depends on how much you earn, you won’t know until the end of the year how much you can contribute. Huh.
Still, if freelancers face unique challenges when saving for retirement, they also have unique opportunities. Funding your retirement account can be considered part of your business expenses, as can any time or money you spend on setting up and administering the plan. Even more important, a retirement account allows you to make pretax contributions, which reduce your taxable income.
Many retirement plans for the self-employed allow you, as a business owner, to contribute more money annually than with an individual IRA.
Self Employed Retirement Savings Plans
There are four retirement savings options on the self-employed side. Some are single-player 401(k) plans, while others are based on individual retirement accounts (IRAs). They:
- One-Participant 401(k)
- September IRA
- simple ira
- keogh plan
With all four of these options, your contributions are tax-deductible, and you won’t pay taxes as they increase over the years (unless you cash out at retirement). Their complexity and suitability vary depending on the size of your business, both in terms of personnel and earnings. Let’s look at each in more depth.
To avoid penalties with any of these plans, you have to leave in your savings account by age 59. However, there are some hardship exemptions.
One-participant 401(k), as it is officially dubbed by the IRS, is also known by the names Solo 401(k), Solo-K, Uni-K, or Individual 401(k). It is reserved for sole proprietors without employees, other than a spouse working for the business.
How a Solo 401(k) Works
One-participant plans closely mirror the 401(k)s offered by many large companies, which is the amount you can contribute each year. The big difference is that you get to contribute as an employee and as an employer, giving you a higher limit than many other tax-advantaged plans.
So if you participate in a standard corporate 401(k), you’ll invest from your paychecks as pretax payroll deductions, and your employer will have the option of matching those contributions to a certain amount. You get a tax break for your contribution, and the employer gets a tax break to match it. With a one-participant 401(k) plan, you can contribute in each capacity, both as an employee (called an optional deferred) and as a business owner (an employee non-elective contribution).
Elective deferment for 2021 could be up to $19,500, or $26,000 if age 50 or older ($20,500 or $27,000 in 2022). Total contributions to the plan cannot exceed $58,000, or $64,500 by 2021 for people age 50 or older ($61,000 or $67,500 in 2022). If your spouse works for you, they can contribute the same amount, and then you can match them. So you see why Solo offers the most generous contribution limits of 401(k) plans.
Setting up a Solo 401(k)
Some paperwork is required, but it isn’t too hard. To set up an individual 401(k), a business owner has to work with a financial institution, which may impose fees and limits on the investments available in the plan. Some plans may limit you to a certain list of mutual funds, but a little buying will turn up many reputable and well-known firms that offer low-cost plans with a lot of flexibility.
“Generally speaking, 401(k)s are complex plans with significant accounting, administration, and filing requirements,” says James B. Twining, founder and wealth manager of Financial Planning. “However, a solo 401(k) is fairly simple. As long as the assets do not exceed $250,000, no filing is required. Yet a single 401(k) may include a multi-participant 401(k). ) The scheme has all the major tax benefits: Pre-tax contribution limits and tax treatment remains the same.
Officially known as a simplified employee pension, a SEP IRA is a variation on a traditional IRA. As the easiest plan to set up and operate, it is an excellent option for a sole proprietor, although it also allows for one or more employees.
How SEP IRA Works
The employer alone contributes to the SEP IRA—not the employee. So, unlike a solo 401(k), you’ll only contribute while wearing your employer cap. You can contribute 25% of your net earnings (defined as annual gains less than half of your self-employment taxes), up to a maximum of $58,000 in 2021 (up to $61,000 in 2022).
The plan offers the flexibility to individual contributions, make them a lump sum at the end of the year, or omit them entirely. No annual funding is required.
Its simplicity and flexibility make the plan most desirable for one-person businesses, but there’s a catch if you have people working for you. Although you are not required to contribute to the plan each year, when you do contribute, you are required to do so for all of your eligible employees — up to 25% of their compensation, limited to $290,000 annually.
While SEP IRAs are simple, they are not necessarily the most effective means of saving for retirement. “You can contribute more to a SEP IRA than to a solo 401(k), except for profit-sharing,” says Joseph Anderson, CFP, president of Pure Financial Advisors, but you should make enough money because it’s a percentage of the profits. based on.” ,
Setting up a SEP IRA
The account is easier to set up than a solo 401(k). You can easily open a SEP IRA online at a brokerage such as TD Ameritrade or Fidelity Investments.
Officially known as the Savings Incentive Match Plan for Employees, a SIMPLE IRA is a cross between an IRA and a 401(k) plan. Although available to sole proprietors, it works best for small businesses. Companies with 100 or fewer employees may find other types of plans too expensive.
How a Simple IRA Works
Simple IRA is as follows…