August 9, 2017
August 9, 2017
If you are self-employed, there several options available for investing for retirement. This includes both traditional and Roth IRAs, SEP IRAs, SIMPLE IRAs and solo 401(k) plans. Which one you choose will depend upon your personal circumstances, as well as how much money you want to save for retirement.
IRAs are the most basic of the various retirement plans. They are easy to set up and can be done through banks, mutual funds, and investment brokers. They are also self-directed so you can invest in any way that you want. Actual investment options are practically unlimited and include stocks, bonds, certificates of deposit, US Treasury securities, mutual funds, exchange-traded funds (ETFs), real estate investment trusts (REITs) and futures and options.
Using an IRA, you can contribute up to $5,500 per year, or $6,500 if you are age 50 or older. If you are not covered by any other type of retirement plan, the contributions are fully tax-deductible. Investment earnings within the plan are also tax-deferred. That means that you can continue to grow your IRA portfolio for many years, free from taxation.
Taxes only apply when you reach retirement age and begin taking withdrawals from the plan. At that point, the withdrawals are added to your income and taxed as ordinary income. If you withdraw funds from an IRA before reaching age 59 1/2, you will also have to pay a 10% early withdrawal penalty on the amount of the withdrawal.
A Roth IRA is basically an IRA, but one with a different tax consideration. While contributions to a traditional IRA are generally tax-deductible, contributions to a Roth IRA are not. Investments within the plan grow on a tax-deferred basis, but while withdrawals from a traditional IRA are taxable, withdrawals from a Roth IRA are not. This means that a Roth IRA account can be an excellent source of tax-free income in retirement.
For the Roth IRA withdrawals to be tax-free, you must be at least age 59 1/2 and have participated in the Roth IRA for a minimum of five years.
Otherwise, a Roth IRA is managed in the same way as a traditional IRA. The accounts are completely self-directed, and you have virtually unlimited investment options.
But Roth IRAs also have two other advantages that make them unique among all retirement plans. Since your contributions to the plan are not tax-deductible, you can actually withdraw them before turning age 59 1/2, but without having to pay income tax on the withdrawals (you will have to pay taxes and penalties on any investment earnings withdrawn from the plan before 59 1/2).
The other advantage is that Roth IRAs are not subject to required minimum distributions (RMDs). Virtually all tax-sheltered retirement plans require RMD’s. Beginning at age 70 1/2, you must begin taking withdrawals based on your life expectancy at the time of the withdrawals. But since Roth IRAs are not subject to RMD’s, you can allow the account to continue to grow for the rest of your life. This will help you to avoid outliving your money.
The Simplified Employee Pension Plan, or SEP IRA for short, can be set up for you as well as any employees you have. It works much the same as a traditional IRA, in that contributions are tax-deductible, investment income accumulates on a tax-deferred basis, and withdrawals are subject to ordinary income tax. Also, if you make withdrawals before reaching age 59 1/2, you will be subject to the 10% early withdrawal penalty.
The main advantage to a SEP IRA is that the contributions that you can make to the plan are much larger. You can make contributions effectively equal to 20% of your income, up to a maximum of $54,000 per year. That means that if you have an income of $100,000, you can contribute $20,000 to a SEP IRA, rather than $5,500 with a traditional or Roth IRA.
This is yet another variation of the traditional IRA. But it also allows you to make a larger contribution than a traditional IRA, though not nearly as large as what you can with a SEP IRA.
With a SIMPLE IRA, you can contribute up to $12,500 to the plan each year, or up to $15,500 if you are 50 or older. What’s more, you can contribute up to 100% of your income to the plan, which means that you don’t have to make a lot of money to make the maximum contribution.
As an employer, you can also make a matching employer contribution. This can represent up to 3% of your income, or a 2% non-elected contribution – of up to $5,000. That effectively increases the maximum contribution to $17,500, or $20,500 if you’re 50 or older.
The SIMPLE IRA is designed for small businesses that employ fewer than 100 employees. It is set up as an employer-sponsored plan, but it otherwise works much like a traditional IRA. That includes the possibility of being self-directed, as well as having unlimited investment options. Contributions are tax-deductible, and investment earnings are tax-deferred. Withdrawals are taxable as ordinary income and are subject to the 10% early withdrawal penalty if taken before reaching 59 ½.
The solo 401(k) plan is a 401(k) plan for an individual self-employed person. The business can include you and your spouse, but it cannot include other employees. And in a weird twist, as a self-employed person, you’re considered to be both the employer and the employee on the plan.
Just as is the case with regular 401(k) plans, you can contribute up to $18,000 to the plan each year, or $24,000 you are age 50 or older. But you can also contribute up to 25% of your business income to the plan as the employer. The maximum contribution overall is $54,000 per year.
The maximum contributions to a solo 401(k) are the same as it is for a SEP IRA. However, you can reach the maximum contribution sooner with a solo 401(k), because of the dual contribution privilege.
If you do take on employees, the Solo 401(k) plan can be converted into a regular 401(k) plan, that will enable you to add your employees to the plan. You can also add a Roth 401(k) plan to your solo 401(k), to enable you to get many of the same benefits as you would get from a Roth IRA.
If you’re self-employed, you have a choice of at least five different self-employed retirement plans. Choose at least one, and start saving for your retirement now. Even if you only settle on a traditional or Roth IRA, you can always add a plan with higher contribution limits later on as your business grows.