Retirement Tips for the Self-Employed

You work for yourself and you can make retirement work for you too

While self-employed people may not always have the luxury of an employer-matched 401(k) or similar retirement plans, there are some potential perks when it comes to retirement planning. Here are some retirement tips to help the self-employed create a feasible, comfortable future for their golden years after they’ve left the workforce.

What’s your number?

The first thing to note is that you should be using a retirement calculator or understanding how to calculate your own numbers so you can decide how much you need to be saving each year which will then help to determine your best route.

For starters, it is always helpful to start saving early and get into the habit of saving more when possible and less when money is tight. Consider insurance so that you can protect yourself from “financial shocks.” You’ll also want to take advantage of government-sponsored retirement programs when possible and educate yourself about the variety of retirement options that are available to you.

The ‘simplified’ route

According to the IRS’s Retirement Plans for Self-Employed People document, updated in 2020, one of the options to save for retirement as a self-employed individual is the Simplified Employee Pension (SEP). With this plan, you can put up as much as 25% of your net earnings from self-employment. However, this does not include contributions for yourself.

This plan is completed by filing your form 5305-SEP or an IRS- approved “prototype SEP plan,” which is offered by mutual funds, banks upon other financial institutions. You will then need to formally open an SEP-IRA through a bank or other institution. Your SEP plan needs to be set up no later than the due date of your income tax return.

Maybe you can have a 401(k) after all

Another possible plan is the 401(k) plan, which the IRS also provides guidance for in its Retirement Plans for Self-Employed People document. This requires making annual salary deferrals up to $19,500 in 2020, along with an additional $6,500 in 2020 if you are 50 years of age or older on a pre-tax basis or as designated Roth contributions. You will also need to contribute up to an additional 25% of your net earnings from self-employment for total contributions of $57,000 – and this includes salary deferrals.
You should make sure that you adjust your plan to allow access to your account balance using loans and hardship distributions.

Match and save

There is also the Savings Incentive Match Plan for Employees (SIMPLE IRA Plan) which allows you to put all of your net earnings from self-employment in the plan, with an additional $3,000 if you are 50 or older along with a 2% fixed contribution or a 3% matching contribution. To create this plan, you will need to complete form 5304-SIMPLE, which is available for use through your selected financial institution where you can also direct your contributions to wherever you wish to setup your account or form 5305-SIMPLE which consists of the company designating the financial institution for the employee.

On the other hand, you can, instead, complete an IRS-approved prototype SIMPLE IRA plan, provided by many mutual funds and banks among others. Along with this, you will need to open a SIMPLE IRA through a bank or other institution. This needs to be done at any time between January 1st through October 1st. Guidance on this plan is also discussed by the IRS’s Retirement Plans for Self-Employed People document.

The traditional option

If you have not been self-employed for an extensive period, you are leaving a job to go start your own or you are saving less than $6,000 a year, it may be best for you to look into the traditional or Roth IRA.

Self-Employed Retirement Plans: Know Your Options document, released by the IRS in 2020, discusses this option and provides guidance for how to get started. You will need to open an IRA and this can be done at an online brokerage within just a few minutes. This is potentially a wise plan for those who do have employees, or even those who do not. You will need to decide, though, which IRA you want to open. If you are just starting out, the tax treatment of a Roth might be better. Be sure you are eligible for the Roth IRA before deciding upon it because those who do earn too much cannot contribute in this plan.

Are you self-employed with no employees?

A self-employed person with no employees and a high income who wants to save aggressively for retirement would probably be best to steer toward a Defined Benefit Plan. Guidance for this is also shared by the IRS in its Self-Employed Retirement Plans: Know Your Options document. The contribution limit for this option is based on the benefit you’ll receive at retirement, your age and expected investment returns. If you think applies to you, you can look into a specific defined plan that would be best suitable for your situation.

Explore further and seek advisory

These are only some tips on getting started and creating a retirement plan that would best fit your situation. There are many more options provided for many different circumstances so, in order to maximize your retirement potential, it is strongly recommended you explore them further.

It is also highly recommended that you engage a financial advisor for retirement who can assist you in establishing a solid plan based on your specific self-employment and financial situation.