Retirement Planning for the Self-Employed
Planning for retirement as a self-employed person isn’t as straightforward as it is for corporate employees. There are no corporate 401(k)s, pensions, or other sponsored plans to fall back on. Chances are that you’ve paid many hard-earned dollars towards the self-employment retirement tax, but you may be rightly concerned that Social Security and Medicare may not be enough to see you through your Golden Years. Fortunately, there are options for your retirement savings, including qualified plans open to the self-employed that can serve as your primary retirement saving vehicle.
Many self-employed business owners count on the sale of the business to fund their retirement. While this can certainly add a significant lump sum to cap off retirement savings, it is imprudent to count too much on the sale of a closely-held asset. Businesses can be notoriously hard to value and selling at retirement requires a combination of timing, luck, persistence, and the right buyer.
Retirement Plans for the Self-Employed
Americans with self-employment income can take tax deductions for contributions made to SEP IRAs, solo 401(k) plans, and Keogh plans. Additionally, you may be eligible for deductions for contributions to a Roth IRA or contributions to a spousal IRA.
SIMPLE IRAs – Savings Incentive Match Plan for Employees: are basic and very easy to set up. These plans are designed for small businesses with fewer than 100 employees and no other sponsored retirement plans. They are most ideal for very small businesses and self-employed workers not making much money since the contribution limits are fairly low. The main benefits of the SIMPLE are that you can open a new one at any point between January and October, they are easy to set up, and they do not require any special reporting to the IRS. Annual contribution limits for 2011 are $11,500 and $14,000 for those aged 50 and older. Drawbacks include very low contribution limits as compared to other plans and an employer-match requirement if you plan to open SIMPLE IRAs for employees.
SEP IRA (Simplified Employee Pension plan): is a relatively simple, straightforward qualified plan that is attractive due to its easy setup, low maintenance costs, and lack of annual reporting. Like 401(k)s and pension plans, they can often hold the bulk of retirement savings for the self-employed. You can contribute and deduct up to 20% of your pre-tax income (or up to 25% if you are an employee of your own corporation) to a maximum of $49,000 or $54,000 for those over 50 in 2011. One of the key benefits is that there are no minimum contributions, meaning you can increase contributions during the good years and reduce (or eliminate) them during the lean times.
Those eligible include: the self-employed, sole proprietors, independent contractors, and those working in partnerships or corporations.
Solo 401(k)s: are substantially similar to those used in companies across the country. Benefits of the solo 401(k) include the ability to contribute more money than in a SEP IRA as well as the ability to include profit-sharing from the business. These plans are often ideal for those with inconsistent incomes who want to be able to maximize their contributions in the flush years. However, solo plans are limited to business owners and their spouses, making them viable only for very small businesses. Annual contribution limits are somewhat complex, being made up of both deferred salary contributions and profit-sharing, however, the total limit for 2011 is $49,000, or $54,000 for those aged 50 and older. Set up and reporting requirements are moderately complex, and those who don’t mind filling out investment forms can cut down on annual expenses considerable.
A note for business owners with employees: 401(k)s are a popular way to attract and retain employees because of their flexibility in investment options, high contribution limits, and profit-sharing potential. They are, however, expensive to develop and maintain. Additionally, they have strict regulations governing investment by managers and employees, which can affect how much you personally can invest in your account each year. In short, highly-paid employees (such as owners and executives) are limited in their annual contribution limits by how much lower-paid employees choose to contribute. If your business employs mostly low-paid employees, it may be best to consider other options.
Saving Strategies for the Self-Employed
While employees can count on a bi-weekly check, and generally know how much they will be earning each month, this is often not the case for the self-employed. Unless you are essentially a contractor for a single client, or have an established business with consistent cash flow, your income may ebb and flow depending on how much work comes in the door. As such, it can be difficult to develop a regular savings plan around variable income.
However, developing a regular savings habit is even more critical for the self-employed, as it can be too easy to put off savings and investments until “things are more stable,” or “this big project comes through.” The key to developing a regular saving habit is to automatically sock away a certain amount each month. Treat your savings like a bill that must get paid every month before you even see it in your checking account. If your income is project-based, it makes sense to add additional lump sums to your savings when those big invoices get paid.
Benefits of a regular savings and investment schedule include:
- Dollar cost averaging – lowering the average cost of your investments by investing small amounts over time, taking advantage of market movements.
- Building savings discipline – treating your savings like a bill means you always pay yourself first every month.
- Giving your investments time – investing smaller amounts earlier in life can add up to much more money than investing larger amounts closer to retirement.
Selling a Business
Depending on your business, it is very likely that you have something of value to sell at the end of your career. If you own a branded business in your area, then you have a brand, business license, and a reputation in the community that is of value. If you are a broker, salesperson, or consultant, then you have a book of business which can be valued and sold. If your business has physical assets, such as equipment, an office or building, vehicles, or special licenses, those can be sold off separately or sold as part of the whole business.
If you intend to sell your business to fund part of your retirement, then it is critical to begin planning for the sale as far in advance as possible – ideally, from the beginning – so that you can structure the business in a way to make it easy to sell.
Don't Put It Off, Jumpstart Your Retirement Plan Today
A comfortable retirement can only be secured with prudent planning, aggressive saving, and disciplined investing. Online research is a good start, but consider the benefits of discussing your options with a qualified financial advisor. The alternative could mean lost opportunities, higher fees, and lack of discipline. Request a free, no-obligation consultation today.Speak with an advisor over the phone about your retirement plan for FREE.