RETIREMENT PLANS FOR SELF-EMPLOYED

Consider this post the cliff notes you need to understand retirement plans as a self employed person.

I will discuss 3 types of retirement plans for self employed.

Stay with me until the end because I am going to summarize each plan so that you can choose the one that is best for you!

I’m Stephanie Barnier, founder and CEO of Clear Sky Wealth. Before I became the owner of Clear Sky Wealth, I was self employed. So, I know that as a self-employed person you need accurate information and strategic ideas that you can get your arms around quickly.

For over 13 years, we have been working with self employed women to help build their wealth and grow their businesses. Today I want to help you too!

Now let’s get into the details of 3 types of retirement plans for self employed:

1) The first type is 401(k)s.

You might know this already, but it is important to know that a 401(k) for self-employed is called “Solo 401(k)” or “Individual 401(k)”.

With a solo 401(k) you are essentially creating a perk for yourself, which is like the employer-sponsored plans that small to large businesses offer their employees.

Let’s talk about some facts of the solo 401(k):

• Designed for business owners with no employees

• You and your spouse can contribute to a solo 401(k). Again, no other employees may contribute.

• The total solo 401(k) contribution limit is up to$57,000 in 2020. There is a catch-up contribution of an extra $6,500 for those 50 or older.

• There are set-up and ongoing costs to maintain a solo 401(k). It is not the most cost-effective retirement plan.

Many of my clients set up solo 401(k)s when their business is in a more mature phase and their income is consistent.

You’ll want a solo 401(k) when your income is relatively consistent. If you are new to self employed or your income is inconsistent, I don’t recommend a solo 401(k) because you need more flexibility in the early stages.

Keep in mind that if you are looking to open a solo 401(k) for your side hustle business, the $57,000 contribution limit also applies to the 401(k) at your day job. In this case,you should max out your contributions to your day job 401(k) vs. opening a solo or having two 401(k)s.

Stick with me in this post, because later I’ll cover a sweet option for those of you that have a day job and side business!

If you have employees, you may want to consider an employer sponsored 401(k) - this is a fancy phrase for a company 401(k). Or a good alternative might be a SEP IRA, for you and your employees.

So let’s talk about SEPs.

2) The second type of retirement plan for self employed are SEP IRA’s.

It is one of my favorites for its flexibility, but SEPs do have more rules. SEP stands for: Simplified Employee Pension Individual Retirement Account (SEP IRA). It is just that simplified. SEP IRAs let self employed and small business owners save up to $57,000 in 2020 towards retirement. They are best for companies with few to no employees.

The best parts of SEP IRA are:

• Easy to set up and administer

• Cost effective compared to 401(k)s

• You don’t have to contribute every year making it one of the most flexible plans

• If you are just starting out in your business, and have an employee or employees, they are eligible to participate in a SEP if they worked for you 3 of the previous 5 years and are 21 year or older.

Some of my clients are in the early stages of their businesses, so income fluctuates from month to month year to year.

SEPs are terrific for their flexibility. In the years when income is lower, you don’t have to contribute to a SEP. And if you have eligible employees for SEP, you aren’t required to contribute to the employees SEP accounts if you didn’t contribute to your own. This is just one perk about SEP IRAs.

This is one strategy that is often overlooked by W-2 employees and self-employed, even when it could be their best retirement plan strategy yet!

Which brings us to our last type of retirement plan for self-employed:

3) IRAs, which are also known as Individual Retirement Accounts.

A traditional IRA is one of the most well known retirement plans. Even so, I want to include it in this post, because it can be a great or alternate solution depending on your income variability, especially in years when profits are lower.

IRA accounts allow individuals to put in pre-tax income - money you don’t have to pay taxes onto day, and this money can grow tax-deferred when invested!

Lastly, let’s look at some strategic ways IRAs can be used:

Say you have a SEP IRA and employees, and this was a year when profits are lower than normal, or you want to use profits to reinvest in your business, or you need more cash for a child going off to college…

You don’t have to contribute to a SEP that year, and you aren’t required to contribute to your employees SEP accounts if you didn’t contribute to your own.But you can still make a contribution to your retirement. Instead of putting money in a SEP, you may contribute to your IRA. You don’t have to close your SEP IRA, you can keep it open to fund in future years.

SO COOL RIGHT!?

That is just one way to use SEP and traditional IRAs with your retirement planning throughout the years. This isn’t the case with 401(k)s and IRAs.

• Traditional IRA contributions are tax deductible, but the amount you can deduct may be reduced or eliminated if you or your spouse have retirement plan or 401(k) at work or if your income is high.

• There are income limits with traditional IRAs. A reference link to this is below.

https://www.irs.gov/retirement-plans/ira-deduction-limits

4) Let’s compare the three types of retirement accounts for self-employed.

I am going to put these up on the screen,you don’t need to know how to calculate them, all you need to know is the concept of each to be able to identify which one is best for you. Hang with me on this, you’ve made it this far, you got this! We’re bringing it home now.

Starting with Solo 401(k):

• Let’s say you earn $100,000 this year and are age 51.

• With a Solo 401(k) you are considered the employee and the employer.

• You contributed $19,500 as an employee plus $6,000 in catch-up contribution -this is allowed when over the age of 50.

• Then you, as the employer, contributed $37,500 to maximize your solo 401k plan for a total of $63,500.

• The Solo 401(k) is the plan you will be able to contribute the most towards retirement over any other retirement plan.

How are you doing with this? So far so good with the Solo 401(k)? Comment below, let me know if you have questions. I know this stuff can sometimes be tricky... hang with me - we’ll get you to the place so you can identify the right retirement plan for you.

Let’s look at the SEP IRA. This one is different from solo 401(k) that your contribution limit is based on a percentage of your earnings.

What do I mean? You can contribute up to 25% of your adjusted net earnings from self-employment.

Or up to $57,000 - whichever one is the lesser of the two.

Remember, I said SEPs are great for their flexibility. If you are newly self employed, it is important you choose the right retirement plan. Let’s look at an example.

Let’s take a look at an example:

• Let’s say you earn $100,000 this year and are age 51.

• You determine your adjusted net earnings are $77,000, you can contribute 25% of $77,000 for a total of $19,250. And there is no catch-up feature to contribute more if you are over age 50.

• Clearly, you can see the difference in the contribution limits in these two examples, $63,500 with the Solo 401(k) and $19,250 with the SEP IRA.

• If you want to stash more away for retirement and your income is relatively consistent, consider the Solo 401(k).

To calculate your adjusted net earnings for the SEP IRA, I have a link to a worksheet below.

https://www.fidelity.com/bin-public/060_www_fidelity_com/documents/SEP-cntrb-wksht.pdf

As for Traditional IRAs:

• The contribution limit is $6,000 for 2020 and $7,000 for over age 50

• Traditional IRAs are a great solution in years that you don’t contribute to your SEP IRA and your income is less than $196,000 filing married or less than $124,000 filing single.

Wheeew... I covered a lot in this post! How was that for you? Were the examples helpful? You can find more financial advice for self employed women at clearskyweath.com. Thank you for watching and building your wealth. I’ll talk with you soon!