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How to Plan for Retirement When You’re Self Employed

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The self-employed don’t have access to traditional 401Ks or pensions. They may also deal with irregular income while focusing on growing their business instead of saving for the future. However, as a self-employed person, you must take the initiative to plan for your retirement. This is true whether you’re an independent contractor, sole proprietor, or member of a partnership. Here’s how to plan for retirement when you’re self-employed.

Understand Your Options

If you are self-employed, the government has set up several tax-advantaged retirement plans. Each option has its pros and cons.

One of the most popular choices is the IRA. Contributing to the traditional IRA gives you an immediate tax deduction. You don’t get a tax write-off for contributing to a Roth IRA, but you won’t have to pay income taxes on it when you retire. We’d recommend either type of IRA if you’re only saving a few thousand dollars a year for retirement. Both types of plans are ideal for contractors and sole proprietorships.

The Solo 401K is an option if you’re self-employed, though it can include your spouse. The biggest point in its favor is how much you can put in. You can contribute either up to $57,000 or 100% of your earned income, whichever is greater. It allows for additional catch-up contributions if you’re over 50.

Contributions are pre-tax, but distributions are taxed. Also, you’ll pay a penalty if you take money out before you’re 59 and a half, and you’ll have to file paperwork with the IRS annually once you have more than a quarter-million dollars in your account.

A SEP IRA is an option if you have no or only a few employees. It has the same contribution limits as a Solo 401K but it lacks the catch-up contributions of the Solo 401K. If you have employees, employers must contribute an equal percentage of the employee’s salary. For example, if you contribute 10% of your contribution to the SEP-IRA, you have to contribute 10% for every eligible employee. This is the biggest downside of a SEP IRA. Setting up a SEP IRA is almost as easy as setting up an IRA, is easier to maintain than a Solo 401K, and you don’t have to contribute every year.

A defined benefit plan is ideal for the self-employed person without employees who wants to continually save a significant amount towards retirement. The contribution limit is calculated based on your age, expected investment returns, and what you’ll get at retirement.

This article on defined benefit plans for the self-employed explains the tax deductions you can receive by contributing to a defined benefit plan. It also explains how much you could save if your spouse can contribute, as well. Furthermore, it lays out the benefits of a defined benefit plan for the self-employed over other types of self-employment retirement options. For example, defined benefits are not bound by the 25 percent compensation limit. You could save half or more of your income in a profitable year while significantly reducing your income tax bill. You could reduce your payroll tax burden as well.

Understand What Government-Sponsored Programs May Be Available to You

It’s important to understand what government programs are available to you and what you’re obligated to contribute. For example, you must understand your mandatory quarterly Social Security contributions as a self-employed person before you start your own business. You’ll owe both the employer and employee contributions. Conventional employees only pay half.

Have a rough idea of how much money you’ll receive in Social Security benefits when you retire. This will affect how much you need to save on your own. Know that you’ll only receive benefits if you’re contributed at least 40 quarters or roughly ten years.

Protect Yourself with the Right Insurance Coverage

If you’re just starting your business, consider doing it on the side while managing your day job. This will not only guarantee you can pay your bills, but allows you to keep your health insurance. Don’t forget to budget for health insurance, liability insurance, and disability insurance when you’re self-employed. This coverage will protect you from major financial shocks that could force you into bankruptcy if you lack such protection.

Automate Savings

There are two ways to maximize your retirement savings. One is to start early, and the other is to automate your retirement savings so that you don’t have to think about it.

If you automatically contribute 5% to 10% of your income to retirement, you’ll typically adjust your spending down to fit what is left. You don’t have to remember to contribute, and you’ll automatically save more when you make more. Alternatively, you could contribute a set amount every month, sending it from your checking account to your retirement account. You probably won’t miss it, but you won’t miss out on the opportunity to invest in a given tax year.

The self-employed tend to do what they love and plan on doing it for the rest of their lives. However, they need to take proactive steps to save for the future because there is no one else doing it for them.