4 Ways Entrepreneurs Can Save for Retirement
By Tyler Olson, CPA, Owner, Tyler James Advisory LLC
Owning your own business gives you a lot of flexibility and options when it comes to saving for retirement. The biggest mistake I see with self-employed individuals is not saving for retirement or not saving enough for retirement. Owning your business allows you to make your own schedule and the freedom to do what you want with your income. Not saving for retirement because you are self-employed though can lead to severe consequences no matter what age you start your business. It is never too early to begin saving, and it is never too late. In general, the earlier you start, the larger the nest egg you will be able to build. That being said, if you are getting a late start, there are several ways to contribute more than the allowed amount as a ‘catch-up.'
Below are four different options for the self-employed to contribute for retirement and also save on taxes. The power of compound interest cannot be underestimated and by starting to save for retirement earlier, rather than later, can lead to millions more saved for retirement in the long run. Note, you can not withdraw money from these accounts until you are 59 ½ (makes sense, right?) without penalty.
Traditional or Roth IRA
Suited for: Entrepreneurs who are looking to start saving small amounts for retirement, and entrepreneurs who have a 401K with an old employer and want to roll that over into an IRA.
Contribution Limit: You can contribute $6,000 in 2019 to a traditional or Roth IRA. Additionally, if you are 50 years old or older, you can add $1,000
Tax Savings: Contributions to a traditional IRA are tax deductible in the year of contribution. Contributions to a Roth IRA are not tax deductible in the year you contribute, but future withdrawals in retirement are tax-free.
Restrictions: There are income restrictions on Roth IRAs. If you make too much income, you will not be able to contribute to a Roth IRA.
The Details: A traditional or Roth IRA is a great way to start saving for retirement if you are looking to get started. While the contribution limits are lower, over time, this can be a valuable asset in retirement.
If you qualify for a Roth IRA, this is a great way to pay taxes on income now, while you are in a lower tax bracket, and have future tax-free withdrawals when your income is in higher tax brackets in the future.
Simple IRA
Suited for: Business with employees that are looking to also contribute to their employee's retirement.
Contribution Limit: You can contribute up to $13,000 for 2019. Additionally, if you are 50 and older, you can contribute an additional $3,000.
Tax Savings: Contributions are tax-free, but withdrawals in retirement are taxable.
Restrictions: Employers are required to match employee contributions up to 3% of their yearly salary or a 2% fixed contribution for all employees eligible for the plan.
The Details: A Simple IRA works best if you have several employees and want to contribute more than a traditional or Roth IRA. When evaluating a Simple IRA, pay attention to the rules around employee match and contribution amounts.
SEP IRA
Suited for: Business owners with no or very few employees.
Contribution Limit: $56,000 or 25% of net self-employment earnings, whichever is lesser. There is no additional catch-up contribution.
Tax Savings: Contributions are tax-free, and any distributions in retirement are taxable.
Restrictions: You must contribute the same percentage to each employee as you add to your SEP IRA. For example, if you contribute 15% of your net self-employment income to your SEP IRA, you must contribute 15% of each employees salary to a SEP IRA.
The Details: If you have no employees, this is your best options for retirement saving as an entrepreneur who wants to save a lot for retirement. Generally, if you have more than a few employees, this is not worth it due to the additional cost.
Solo 401k
Suited for: Self-employed individuals with no employees.
Contribution Limit: The lessor of $56,000 or 100% of income earned for 2019.
Tax Savings: Contributions are tax-deductible, but any distribution made in retirement is taxable.
Restrictions: If your business has employees, you cannot open a Solo 401K (except a spouse, who can also contribute as an employee).
The Details: If you are in a position to save a lot for retirement and do not have any employees, this is an excellent option for you. It allows you to get tax benefits and have a higher contribution limit than most of the IRAs. You can also choose a Roth Solo 401K if you would like to pay the tax on the money now, and get tax-free distributions in retirement.
Conclusion
Retirement is a considerable investment, and with proper planning, can be some of the best years of your life. You are never too early or too late to start planning for retirement. Do your research, pick the right advisor, and let your money get working for you!