How to ensure that you have the right savings tools in place for the next chapter of your life.
Sole proprietorships with no employees, including consultants and freelancers, account for more than three-quarters of the nation’s small businesses.1 And with the many freedoms of being a sole proprietor come some responsibilities that you don’t have as someone’s employee—like building a retirement plan. In fact, 34% of sole proprietors don’t have any financial provisions for retirement.2 Nearly the same percentage (36%) plan to keep working after retirement.2
Besides the obvious benefit of providing for your future, there’s another compelling reason for having a retirement plan: potentially lowering your taxes. Unlike an incorporated business, the IRS taxes solo entrepreneurs on their business’s total earnings as personal compensation. So, the more income you can direct to tax-deferred savings, the better.3
Know Your Options
Consult with a financial advisor and your accountant to determine if and how you want to reinvest any former employer-provided accounts into your new portfolio. Then, consider these investment vehicles for the self-employed. You may be surprised at the flexibility they offer you as a free agent.
Much like the employer-sponsored 401(k) you likely had through your previous job, this one sets you up to contribute a defined percentage of your income on a regular basis. This type of plan, which caters to the needs of entrepreneurs (and their spouses) who have no employees, is also the most popular among soloists. It differs from employer-provided 401(k) accounts, since you can contribute to your fund as both the owner of your business and as its employee.
When you consider current IRS limits, this adds up to a $56,000 contribution with those over 50 able to defer an additional $6,000 of their earnings. Some plans also permit after-tax Roth contributions, which means you’ll be able to make tax-free distributions upon retirement.
SEP (Simplified Employee Pension) IRA
Unlike other retirement accounts that require contributions within the tax year, you can set up and contribute to a SEP IRA account when you file your tax return, with those funds applying to the previous year’s income. This gives you a high degree of flexibility, since you can review your profits and overall tax picture first, then determine your optimal contribution amount (up to 25% of your income, up to $56,000).4
SIMPLE (Savings Incentive Match Plan for Employees) IRA
This plan accommodates the entrepreneur with an unpredictable income, which is the case for many fledgling soloists, as well as those in seasonal or other professions with irregular employment. The IRS gives you until October 1 to open and contribute to your SIMPLE IRA for that tax year. Keep in mind the deferment maximum, at $13,000, is lower than many plans; it rises to $16,000 if you’re 50 years old or older.4
Defined Benefit Plan
This is essentially an annuity that you create and fund, which will later provide you with a fixed amount of money, just like a company pension. The defined benefit plan gives you maximum security and predictability. However, it’s costly and potentially complex: You’ll need to hire an actuary or a third-party administrator to construct and document the plan. Ongoing costs include annual tax filings that can cost a few thousand dollars, depending on your accountant’s fees.5
Don’t Go It Alone
To get the most of all the retirement resources available, talk with your business banker. They can refer you an accountant or financial planner in their network, if you don’t already have one, who can get you on track with your savings goals.
1 What is a Business? Rise in Self-Employed Challenges the Common Wisdom, U.S. Census Bureau, Census.gov, 2019, https://www.census.gov/library/stories/2019/03/what-is-a-business.html
2 “One-Third of Small Business Owners Don’t Have Retirement Savings Plan,” Manta.com, 2017, https://www.manta.com/resources/small-business-trends/small-business-retirement-savings-plan/
3 Sole Proprietorships: What You Need to Know to Get Started, Fundera.com, 2019, https://www.fundera.com/blog/sole-proprietors
4 Self-Employed Individuals Tax Center, Irs.gov, https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
5 Choosing a Retirement Plan: Defined Benefit Plan, Internal Revenue Service, Irs.gov, https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-defined-benefit-plan