So…you’ve joined the ranks of other entrepreneurs and have decided to work for yourself. While that can be liberating, it also brings about an added sense of responsibility. No longer can you rely on an employer to offer a retirement plan. You’re now on your own to start building your own nest egg. It’s a crucial step you don’t want to push off to a later date.
There are many choices available to the self-employed. The important part is determining which one is the best fit for you. Let’s explore some of the options.
Anyone with earned income can open an IRA. Traditional and ROTH IRA’s have different benefits. Although the contribution limit is the same, one’s income may limit how much you can contribute to a ROTH.
Contribution Limits: A total of $5,500 for 2017 (if you’re older than 50, you can add an additional $1,000)
Tax Benefits: A traditional IRA is deductible, however, contributions to a ROTH IRA are not. While you’ll be taxed on withdrawals from a Traditional IRA, withdrawals from a ROTH IRA will be tax free in retirement.
If you’re just starting out, this is great way to start. As your income increases, consider some other options, which will allow for higher contribution limits.
SEP-IRA (Simplified Employee Pension)
A SEP-IRA is a great option if it’s just you, or even a few employees. This is considered an employer contribution plan…and since you are your own employer, you’ll be making the contributions. Keep that in mind if you have employees. Any contributions to the plan will be made by you, not the employee.
Contribution Limits: Contribute as much as 25% of your net earnings from self-employment, up to a maximum of $54,000 for 2017. Whatever percent you select must be applied across the board to all employees.
Tax Benefits: All contributions are deductible. However, make sure you don’t over-contribute; otherwise, you could be stuck with a penalty. The IRS provides a number of “fix-it” solutions if this happens to you.
You can set up and contribute to a SEP-IRA up until you file your taxes (including extensions). There are no IRS reporting requirements and setup is fairly easy.
Although a sole proprietor can setup a SIMPLE-IRA, it is also a great solution for employers with fewer than 100 employees. In a SIMPLE-IRA, there are distinct employee and employer contributions.
Contribution Limits: You may contribute up to $12,500 for 2017. An additional $3,000 is allowed if you are over age 50. The employer is also required to contribute under one of these two options: A fixed 2% contribution based off net earnings (if self-employed), or a 3% dollar for dollar matching contribution (which may be lowered within certain parameters).
Tax Benefits: All contributions are deductible.
Remember, if you a sole proprietor, you are treated as both the employee and the employer in this case. Employee contributions must be made within 30 days after the end of the tax year. Employer contributions must be made by the filing tax deadline, April 15th of the following year, or by October 15th, if filing an extension.
A Solo 401(k), also known as a uni-401(k), or an individual 401(k), offers the same benefits as a traditional 401(k) offered through an employer. A Solo 401(k) can be used if it’s just you, and no employees, unless it is your spouse. If so, then it can be used for you and your spouse. Just like a SIMPLE-IRA, you act as both the employee and the employer.
Contribution Limits: As the employee, you can contribute up to $18,000 of your net earnings from self-employment for 2017. You may add an additional $6,000 if you are over age 50. As the employer, you can also contribute up to 25% of net earnings from self-employment. Total contributions into the participant’s account may not exceed $54,000 (for those under age 50).
Tax Benefits: As with a traditional 401(k), contributions are deductible.
A Solo 401(k) is generally required to file IRS Form 5500 annually. You may be exempt if your plan assets fall under $250,000.
As long as you don’t hire anyone other than a spouse, you won’t be required to undergo discrimination testing. Keep in mind if you hire employees, the no-testing advantage goes away.
The most important thing to remember is to follow the old adage and “Pay yourself first”. According to Statistic Brain, 40% of working Americans are not saving for retirement. Make yourself and your future a priority. If you don’t, no one else will.