Retirement Accounts for the Self-Employed: The Best Options for You
When you retire, you can avoid making mistakes by picking the right retirement plan for yourself and your business.
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Self-employed people and business owners have to do more research than other people to learn about different retirement savings plans. These plans are not automatically offered like employer-sponsored 401(k) or pension plans.
There are different types of retirement plans for self-employed people. We will talk about each class and then tips on opening the correct retirement account. Once you have opened the account, you can start saving money to have a successful retirement.
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Traditional or Roth IRA
An Individual Retirement Account (IRA) is a retirement account that anybody can use. Self-employed people are included. When you contribute to an IRA, you may be able to save on taxes, depending on your income and the type of account you choose.
You can deduct your contributions when you file your tax return with a traditional IRA every year. The money you make from the IRA will be taxed when you take it out, but it will be taxed according to your tax rate.
In various ways, a Roth IRA varies from other types of IRAs. With a Roth IRA, you pay taxes on the contributions when you make them. But when you take the money out in retirement, you don’t have to pay any taxes on it.
However, there are some limitations on the value of an IRA, depending on your situation:
- You can contribute up to $6,000 to an IRA in 2021, or $7,000 if you are 50 or older.
- If you contribute more money than the annual limit to your IRA, you will be taxed 6% for every year the money stays in your IRA.
- The amount you can contribute to a Roth IRA depends on your modified adjusted gross income on your tax return. If your income is too high, you may not be able to contribute at all. But if your income is lower, you may only be able to contribute a limited amount.
- The amount you can deduct for contributions to a traditional IRA may differ depending on how much money you make. If you have a job that offers a retirement plan, your deduction limit might be lower.
- If you get out of your money in IRA before turning 59 1/2, you may be subject to taxes and a 10% penalty. However, there are some exceptions to this rule.
IRAs can be an excellent way to save money for retirement. They have a low annual contribution limit, but that doesn’t mean they’re not a good option for retirement savings.
A solo 401(k) is a retirement account designed for people who own their small businesses and do not have any employees.
Solo 401(k)s work similarly to employer-sponsored 401(k)s. You make contributions with pre-tax money, and these contributions grow tax-deferred until you take withdrawals when you retire.
There are, however, a few differences. For starters, as a business owner, you can contribute both as an individual and as an employer:
- In 2021, you can contribute up to $19,500 to your employee account. You can add $6,500 if you are above 50.
- As a business owner, you can contribute money to your employer. It will help your employer, and you will be able to give more money. The most you can provide is $58,000 in 2021.
You can count the money your employer contributes to your retirement account as a business expense. It will reduce how much tax you have to pay each year. Solo 401(k)s are relatively inexpensive, depending on which plan provider you choose.
You can set up a loan with your solo 401(k) account, but you will have to pay interest on the loan. Also, remember that you shouldn’t take money out of your retirement account unless you have no other choice.
To wrap things up, here are some potential drawbacks of a solo 401(k) to think about:
- If you take money out of your solo 401(k) account before you are 59 and a half years old, you will have to pay taxes on the money, and you will also have to pay a 10% penalty. There are some exceptions, but they are fewer than there are for IRAs.
- If you have any employees who are not your spouse, you are not eligible to open this plan. However, if you hire 1099 workers, they do not count towards this limit.
- You may not be eligible for the IRA plan if an employer-sponsored retirement plan covers you. For example, if you work as an employee at a company and run a side business in your spare time.
Suppose you are an independent contractor or a sole proprietor who doesn’t have any employees. In that case, you might want to consider setting up a solo 401(k). Even if you employ your spouse, you can still qualify for this retirement account.
A Simplified Employee Pension IRA is a form of IRA that you can set up to benefit either yourself or your employees. The fundamental distinction between a SEP IRA and a standard or Roth IRA is that an employer can only fund a SEP IRA.
As an employer, you can contribute up to 25% of an employee’s salary, including your salary. Still, the total amount cannot be more than $58,000 in 2021. A SEP IRA is equivalent to a standard IRA in terms of taxes. It means that your earnings will grow without being taxed and your contributions as the employer are tax-deductible.
You can make separate contributions to a traditional or Roth IRA, depending on what you want. Sometimes, you are allowed to put your personal IRA contributions into your SEP IRA.
When you use a SEP IRA, these are some of the most common problems that can happen:
- A SEP IRA is different than a solo 401(k). A SEP IRA allows only employer contributions, while a solo 401(k) lets you contribute as an individual and employer.
- If you have employees, you must put the same amount of their pay into the retirement plan. The last day of the year includes employees who are no longer employed.
- When you take a withdrawal from your IRA before you turn 59 1/2 years old, you will have to pay income tax on the distribution and a 10% penalty. However, some exceptions to this rule are the same as traditional and Roth IRA exceptions.
- You cannot borrow from a SEP IRA the way you can from a solo 401(k).
A SEP IRA is tax-deferred savings account for small business owners. They can contribute more money than they could with a regular IRA. There is less paperwork than with a solo 401(k).
An IRA Savings Incentive Match Plan for Employees allows employers and employees to contribute to a traditional IRA. In 2021, you can contribute $13,500 as an individual or $16,500 if you’re age 50 or older. The same limit applies to any employees. As the employer, you can also contribute 2% of compensation or a matching contribution of up to 3% of compensation.
You can get a tax deduction for the year you make your contributions to a SIMPLE IRA, and your earnings will grow without being taxed. You can also contribute to a regular or Roth IRA on your own.
Below are some points concerning the SIMPLE IRA:
- SIMPLE IRAs are similar to solo 401(k)s but have lower contribution limits.
- You cannot borrow from a SIMPLE IRA the way you can from a solo 401(k).
- To open a SIMPLE IRA account, you may need to work with a custodian.
- If you get your money out of your IRA before turning 59 1/2, you’ll have to pay income tax and a 10% penalty.
- There are some exceptions to this rule, just like with other types of IRAs.
Suppose you want to save for retirement as both a business owner and an individual. A SIMPLE IRA might be a viable alternative for you in such an instance. This self-employed retirement plan has lower contribution limits than a solo 401(k). Still, it might be better to have employees who don’t qualify for a solo 401(k).
A Health Savings Account can be used to save for retirement. You can use this account and another retirement plan if you are self-employed. You can also use a traditional or Roth IRA.
HSAs are available to people who have a high-deductible health plan. You can put money in the account for medical expenses that you might have to pay. It is called a ‘tax-free basis.’ That means you don’t have to pay any taxes on the money when you take it out if it’s for medical expenses. Suppose you take it out for other reasons like if you don’t have a medical emergency, you will have to pay income taxes and a 20% penalty.
Suppose you wait until you are 65 or older to withdraw money from your HSA account for non-medical reasons. You will only have to pay income tax on the money, but not the extra 20% penalty. An HSA can work like a retirement account where you don’t have to pay taxes on the money. However, you can also use HSA funds to pay for health care costs in retirement and avoid all tax-related expenses.
In 2021, you can contribute up to $3,600 to an HSA if you’re the only one on your health insurance plan. If you have a family plan, you can contribute up to $7,200. Depending on your HSA provider, you may be able to invest these funds.
Here are some things to think about if you’re considering establishing an HSA:
- HSAs are not the only way to save for your retirement. You should not rely on them entirely.
- If you don’t have a high-deductible health plan, you won’t be able to qualify for an HSA.
- HSA contribution limits are lower than most other retirement plans for self-employed people.
If you qualify, consider an HSA as a way to supplement your other retirement contributions. However, keep in mind that any ongoing medical expenses may make it difficult to use the funds to save for retirement.
Other Retirement Plans
There are other small business retirement plans, depending on your financial situation. Here are a few less-common options that self-employed people might consider:
- Keogh plan: A Keogh plan is a retirement plan you can set up if you are self-employed. There are two types of Keogh plans defined benefit and defined contribution. Both types have more rules and costs than other self-employed retirement plans.
- A Keogh plan or a separate defined-benefit plan allows you to contribute a predetermined amount to receive a fixed amount each year in retirement. How you set up the goal may limit how much you may donate.
- Profit-sharing plan: This type of retirement plan gives employees a share of the profits from the business. There are no employee contributions, and the business’s contributions will depend on how well the company does each quarter or year.
There is more than one variety of pension or retirement plan to choose from. You need to do some research on all of your possibilities and decide which approach would be most beneficial to you. When it comes to arranging your finances for the upcoming tax year, you should seek the advice of a tax expert as well as a financial consultant to determine which retirement strategy would be most beneficial for you.
How to Open these Plans if you’re Self-Employed
You can usually get a self-employed retirement plan from a major brokerage firm. However, some brokers may not offer specific goals, so deciding which method you want before shopping around is essential.
When you are comparing brokers and their self-employed retirement plans, review several features, including:
- Cost (setup and ongoing fees)
- Ease of use and access
- Administrative help
- Investment options (mutual funds, ETFs, etc.)
- Resources and advice
There is no one best investment broker for everyone. You need to take your time and find a brokerage that is right for you and your business.
Self-employment is a great way to make your hours and have more control over your work. But it also means that you are responsible for saving for your retirement. It’s necessary to start saving as soon as possible to have more choices when you’re ready to stop working.
There are a variety of retirement accounts, and each kind of account comes with its own set of advantages and disadvantages. To determine which account is the most suitable for you, you should think about the things you want to accomplish, how much money you can put away, and your current financial and tax circumstances. Before making a choice, it is vital to take into consideration the expenditures, maintenance, and potential issues associated with each account. Planning for retirement might take some time, but it is worth it to set up the appropriate account so that you don’t make any mistakes that could end up being expensive in the future.
Read more: When You’re Tiptoeing Into Retirement, Take These Key Steps
Frequently Asked Questions About Retirement Accounts for the Self-Employed
An IRA is a good way for self-employed people to start saving for retirement. It doesn’t require any extra setup, and it may be used whether or not you have staff.
Traditional IRAs and Roth IRAs are not just for people who work for themselves. People who own their businesses or work independently can also contribute to these plans. With Traditional IRAs, you can make tax-deductible contributions. It means that you don’t have to pay taxes on your money. Roth IRAs are different because your contributions are made after paying taxes on the money. But your money will grow tax-free.
As the business owner, you are both the employer and employee of the plan. You can contribute more money to your retirement plan than if you were an employee in someone else’s 401(k) plan. You are allowed to open a solo 401(k) plan, regardless of what type of product or service you provide.
If you are self-employed, you can start a 401(k) plan for yourself. It means that you will be both the employee and employer. It is an excellent way to save money because you can put more money into the 401(k) than if someone else was your employer.
A Roth IRA is a kind of individual retirement account in which you pay taxes on the money you put into it. You will not have to pay taxes on any money you take out of your Roth IRA in the future, as long as you follow the rules. If you know your taxes will be higher in retirement than they are now, a Roth IRA is a superior alternative.
If you set up a SEP IRA for yourself, you must also set one up for each eligible employee. It includes employees who set up their accounts. Suppose you contribute to your SEP IRA in a given year. In that case, you must contribute the same percentage of salary to each employee’s account.
You can save 10% to 15% of what you earn each year instead of each paycheck. This way, you will have a yearly goal for how much money to save for retirement. You can then slowly save money each month to reach that goal.