Retirement Savings 101 for the Self-Employed
Six out of ten self-employed individuals are not making regular contributions to their retirement savings, according to a 2015 survey conducted by TD Ameritrade. What is interesting is that self-employed individuals have perhaps more retirement options than any other type of worker.
If you are self-employed, there are many options that may allow a tax savings opportunity, as well as a vehicle to reach your retirement savings goal. In many cases, you are allowed to make contributions to your plan under two “hats,” both as an owner/employer and as an employee.
Traditional and Roth IRAs are the most basic types of retirement savings accounts to which a self-employed person can annually contribute. Any individual can open these types of accounts, and they are easy and inexpensive to start. However, IRAs can be limiting, as they only allow annual contributions up to the lesser of $5,500 (for 2016) or earned income (with an additional $1,000 for individuals age 50 or older). Traditional IRA contributions may also be fully deductible to a self-employed person, regardless of income limits, if neither spouse is covered by a retirement plan.
A SEP IRA is a type of retirement savings account that also allows a self-employed person the flexibility to contribute to their retirement savings. As an owner/employer, you can contribute up to 25% of your compensation (up to $53,000 in 2016) to your SEP IRA, and you are not required to contribute every year. If you have employees, you may also be required to make contributions on their behalf in any year you contribute to the plan. A SEP IRA allows the self-employed individual the discretion of contributing less in a year when their business did not perform as well. As a small business owner, this may be appealing because SEP IRAs are easy and inexpensive to set up, and contributions are tax deductible against business income.
A SIMPLE IRA is a type of retirement savings account that requires the employer to make a contribution each year for participants (a match of up to 3%, or a flat 2% of pay). If you are a self-employed person, this means you are able to contribute to your SIMPLE IRA as an employee (up to $12,500 in 2016, with an additional $3,000 for individuals age 50 and older) as well as match the contribution as an employer/owner. This type of account is appealing to business owners who would like to maximize their contributions as both an employer and as an employee. Contributions are also tax deductible. Limitations on SIMPLE IRAs include having fewer than 100 employees and not having any other retirement plan offered besides the SIMPLE IRA.
Solo 401(k)s can be an excellent choice for a sole proprietor without employees, who is seeking a retirement savings plan. Solo 401(k) plans operate similarly to an employer sponsored 401(k), as participants can make contributions from income up to $18,000 annually in 2016 (an additional $6,000 for those age 50 and older). Depending on the plan, this contribution may be designated as pre-tax (deductible) or after-tax (Roth). On the owner/employer level, the sole proprietor can also contribute an additional 25% of their compensation. These contributions are tax deductible from business income. Note that the employee and owner/employer contributions together may not exceed $53,000 in 2016. This type of account is best for the self-employed person who has the desire and ability to shelter a larger sum for retirement.
These are just some of the many retirement savings options available to self-employed individuals. Keep in mind that each plan has specific participation, set-up, and reporting requirements that must be met. With more options than a typical employer sponsored 401(k), self-employed individuals should take the time to explore all their options and talk with their financial advisor to determine what works best for their financial goals and business plan. After choosing the right plan, making regular contributions will help your retirement savings grow.
This has been provided for informational purposes only and should not be construed as financial, investment or tax advice. Please consult your financial professionals regarding your specific situation