Build Security With the Right Self-Employed Retirement Plan
Retirement may be the furthest thing from your mind when you’re self-employed. As your own boss working in a field you’re passionate about, you may not plan to ever retire.
But, an unexpected illness, rising costs due to inflation or a change in your industry could put a wrench into your plans to work well into your retirement years. That’s why it’s important that you have a plan in place — and a nest egg built up — so that you have enough money to live comfortably if the time comes when you’re no longer working or are working much less.
Understanding the importance of retirement planning
When you work for a business or company, you can usually take advantage of the company’s 401(k) retirement plan to help you save for the future. But if you’re self-employed and you’re own boss, you have to rely on other options to build your savings.
Being self-employed means you’re solely responsible for building your own retirement savings. While this may sound daunting, it does come with tax benefits. Let’s explore the options that are available for self-employed retirement plans.
Exploring self-employed retirement plan options
When looking at self-employed retirement options, there are four main possibilities to choose from: a traditional IRA, a Roth IRA, a Simplified Employee Pension (SEP), or a solo 401(k). The main differences between these options are how much you can contribute annually and whether your contributions are subject to taxation.
Traditional IRA and Roth IRA
A traditional IRA is one of the most commonly used retirement plans for people who are self-employed. With a traditional IRA, you contribute pre-tax dollars into the account. You pay taxes on that income when you withdraw it in retirement. While traditional IRAs are usually for individuals, a SIMPLE IRA (Savings Incentive Match Plan for Employees) is more suited for business owners with employees.
The benefit of putting your money in a traditional IRA is that your contribution may be tax deductible if it meets contribution limits for the year. That means you can deduct the amount from your income for the year it is made, thus lowering your taxable income and taxes for the year.
A Roth IRA is similar to a traditional IRA but with one key difference: the income you contribute is already taxed. When you withdraw it in retirement, you can do so without paying taxes on that income as you would with a traditional IRA. However, a Roth IRA isn’t tax deductible so it won’t help lower your taxable income for the year the contribution is made.*
So, the decision between a traditional IRA and a Roth IRA boils down to whether you want to pay taxes on your income now (Roth IRA) or when you withdraw the money in retirement (traditional IRA).
In 2024, the total contribution limits for all your traditional and Roth IRAs are set at $7,000 for people under 50 and 8,000 for those over 50. You can easily set up a traditional or Roth IRA through a bank, stockbroker, mutual fund or life insurance company. A Mutual of Omaha advisor can help find a solution that’s best for you.
SEP IRA
If you’re a business owner, you may want to consider a SEP IRA. You can set up a SEP IRA just for yourself if you’re self-employed without employees, or if you employ family members, like your spouse, a SEP IRA enables you to contribute to traditional IRAs for yourself and your spouse.
The most significant benefit of a SEP IRA is that the contribution limits are much higher than those of a traditional or Roth IRA. As of 2024, the SEP IRA contribution limits are $69,000 or up to 25% of income, whichever amount is less. This is advantageous if you’re self-employed without employees, because you can deduct more from your taxable income. However, it’s important to note that there are special rules for determining compensation for self employed, which is usually limited to 20% of your net income.
However, if you’re a business owner and have employees, you must contribute the same percentage to their accounts as your own. For example, if you contribute 15% of your income to your account, you also have to contribute 15% of an employee’s income to their account.
Solo 401(k)
A solo 401(k) also enables you to contribute more to your retirement account than a traditional or Roth IRA, and you can do so pre-tax with a solo traditional 401(k) or after-tax with a solo Roth 401(k). If you’re over 50, you can also make “catch-up” contributions.
A solo 401(k) operates similarly to a 401(k) that you would get working for an employer. However, in this case, you contribute to the account as both the employer and the employee. As an employer (of yourself), you can contribute up to 25% of your income with income up to $345,000. Then, as an employee, you can contribute the lesser of up to $23,000 or 100% of your earned income.
The total contribution limit for 2024 is $69,000 if you’re under 50 and 76,500 if you’re 50 and over. The catch-up contribution limit is $7,500 for those who are eligible.
To be eligible to open a solo 401(k) you must have an employer identification number, but you can’t have any employees, unless the employee is your spouse and is employed by the business.
Tips for investing in your self-employed retirement plan
Choosing the best self-employed retirement option is half the battle. You don’t have an employer automatically taking part of each paycheck and sticking it into your 401(k), so it’s up to you to set aside that money. Here are a few tips to help you invest in a self-employed retirement plan.
- Set a goal: Decide when you plan to retire, or scale back on work and calculate how much you’ll need to live comfortably using our handy retirement savings calculator. This can give you an idea of how much you should put into your self-employed retirement plan.
- Automate your savings: Chances are you already have a system for setting aside a portion of your income for quarterly taxes. You should have one for retirement savings as well. Several financial institutions offer accounts that automatically transfer a set amount or percentage of deposits into savings.
- Make catch-up contributions if you’re eligible: If you’re over 50 and behind in your retirement savings, consider a self-employed retirement plan that allows you to make catch-up contributions.
Bottom line
There are many benefits to being self-employed. You can set your own hours and have more work life balance. However, it also means that you alone are responsible for paying your taxes, finding health care and saving for retirement.
There are several retirement plan options designed to help self-employed individuals save for the future. Our trusted advisors at Mutual of Omaha can offer retirement advice, help you set goals, discuss options and help find a retirement solution that may be right for you.
DISCLOSURES:
*To withdraw funds from your Roth IRA without penalties, you must be at least age 59 ½. You also can’t make withdrawals until at least five years after the beginning of the tax year when you made your first contribution.
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Mutual of Omaha Investor Services, Inc. and its representatives do not provide tax or legal advice; therefore, it is important to coordinate with your tax or legal advisor regarding your specific situation.
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