If there’s been one defining trend for American workers in the past 50 years, it’s the continual transfer of risk and responsibility to individuals to manage their own retirement. At one time, defined-benefit pensions and Social Security acted as the foundation for a secure financial future, but this shifted over time as workers were asked to become de facto financial planners through 401(k)s and IRAs. Now, many workers have become their own employers as well, either by establishing their own small businesses or becoming independent contractors.
There are few things in life that entail more risk and responsibility than running your own business. Unfortunately, given the difficulties inherent in being an entrepreneur, retirement planning can often become an afterthought. However, establishing tax-deferred retirement accounts for your business has become surprisingly easy in recent years, especially if you don’t have any employees other than yourself and your spouse.
Jump Start Your Retirement Savings
The easiest way to start is just to take the path of least resistance. Many small business owners forget that even though they may not be traditional employees any more, they can still contribute to a traditional or Roth IRA, just like their 9-to-5 brethren. All you need to contribute to such an IRA is earned income; the source of that income doesn’t really matter. Given the ease in which an IRA can be opened, there is little reason not to start your retirement planning with these flexible, low-cost tax vehicles.
Of course, these IRAs are hampered by one considerable constraint: their low contribution limits. In 2013, you can only contribute $5,500 to either a traditional or Roth IRA, which is not nearly enough for even the most frugal of spenders. Fortunately, there are other retirement accounts that are specifically designed for entrepreneurs who are looking to put away considerably more money for retirement, including the SEP-IRA and solo 401(k).
Take a Non-Traditional Savings Route
The SEP-IRA and the solo 401(k) are all very similar to the traditional IRA – although solo 401(k)s now come with a Roth option as well – but they have much higher contribution limits. Both accounts allow “employer contributions” of 25% of your income. In addition, the solo 401(k) allows for an “employee contribution,” which works just like a contribution that you would make into a regular 401(k) if you were a regular employee: you can add 100% of your pay up to $17,500 per year into the account. The benefit of this setup is that you can contribute more money upfront, which is a considerable benefit to entrepreneurs who may not bring in a large income. Regardless of how you contribute, however, your total contribution cannot exceed $51,000 per year.
Consult a Professional Who Knows About Business Ownership
Unfortunately, things are a bit more convoluted because your actual contribution schedule depends on the structure of your business. Specifically, things tend to be a bit different for sole proprietors, which include most independent contractors and freelancers, and self-employment profits must be adjusted to take account of the deduction for one-half of the self-employment tax. The IRS does provide worksheets to help you figure out your actual contribution limit, but it would still be a good idea to consult a CPA or a financial planner to help you figure it out; given the penalties involved with over-contributing to your retirement accounts, hiring a professional would be well worth the cost.
Saving for retirement as a self-employed individual takes do-it-yourself planning to a whole new level. Finding an administrator and dealing with all the paperwork can be a nuisance, but it is certainly worth the effort given the tax benefits. Of course, if you don’t want to deal with all the particulars, a financial planner or other professional who understands the intricacies of small business retirement planning can help you navigate all the pertinent tax laws, so you can concentrate on running your business.
For more information or to set up a free consultation, contact Pathway Financial Planning at 248-567-2160 or email firstname.lastname@example.org