Retirement Planning for Self-Employed Individuals

5 min read
May 21, 2014

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Once you understand the basics, planning for retirement can be pretty smooth sailing if you have the opportunity to start saving early enough. After all, time is the biggest advantage you have when it comes to investing and growing your nest egg. The sooner you start, the more wealth you can accumulate over the years.

As an employee, you may not have to plan for retirement alone. Just as your employer provides benefits like health insurance and paid time off, many companies and businesses offer some sort of retirement plan for their workers.

Employees can opt to open accounts - which will generally be a 401(k) or similar account (like a 403(b) if you’re an educator) - through their employers. This is advantageous because any money contributed upfront will grant you a tax break in the present year, as these retirement accounts are tax-deferred.

It's also advantageous for employees to contribute if there’s an employer match. If you company says, “if you contribute 5% of your income to this retirement account, we'll match your contributions and put in 5% as well.” That's free money! Take advantage of the opportunity.

Employees should be especially eager to get their match and appreciative of this benefit, as not everyone receives it. That free money is something that people who don’t have employers won’t get. Self-employed individuals not only have to pay in the employer's and employee's portion on taxes, but they also have to take responsibility for contributing 100% on their own to retirement accounts.

Retirement planning can be a little trickier if you're self-employed. But that doesn’t mean it’s impossible. Check out our tips for freelancers, contractors, and entrepreneurs on mapping out a secure, successful retirement.

Start with the Basics

The best place to start retirement planning for self-employed folks is with an individual retirement account, or IRA. You can go with a traditional IRA or a Roth IRA; both have contribution limits of $5,500 for 2014 if you're under 50.

The biggest difference is what kind of tax break you'll receive. With a traditional IRA, the taxes are deferred. You'll receive a tax break in the year you contribute funds, but you'll be taxed when you withdraw your money. Money you contribute to a Roth IRA is taxed in the same year, but that's it.

This means with a Roth, you're earnings grow tax-free. Traditional wisdom says if you expect to retire in a higher tax bracket than one you're in today, it's advantageous to contribute to a Roth. You won't be able to beat the savings on taxes.

But if you're in a situation where you'll actually be able to contribute more this year if you know you won't have to pay so much in taxes, consider the traditional IRA. Yes, you'll be taxed on your money later - but you'll have more of it down the road if you save more today.

A traditional or Roth IRA is a great place to start your retirement planning for self-employed situations. It's simple, it's easy, and you can hang on to it and continue to contribute if you ever do transition back into an employee role.

Retirement Planning for Self-Employed Workers: Three Major Options

If you can max out either a traditional IRA or a Roth IRA, that's wonderful - but now things get a little more complicated.

Self-employed individuals have three options for their retirement savings:

  • Solo 401(k)
  • Simple IRA

Your unique situation will help you determine which account is right for you and your retirement plans. Let's go through a quick rundown of each:

SEP IRA: Feeling limited by what you can save in a traditional or Roth IRA? The SEP IRA is going to make you really happy. This allows for self-employed individuals to contribute 25% of their earnings, up to $52,000 (for 2014). You can hold this account if you're only self-employed part time, as well; you can contribute to both a SEP and a company 401(k) simultaneously.

SEPs are also tax-deferred, which means you score a tax break in the year you contribute. For those already paying higher tax rates on top of self-employment tax, this could allow you to save way more than you would have been able to previously.

Solo 401(k): Depending on what your earnings look like and the amount you can afford to put away every year, a Solo 401(k) might be a better option than a SEP IRA. That's because it might allow you to save even more than the SEP. The contribution limits is $17,500 for 2014, which might work out to more than 25% of your income (as allowed by the SEP). However, there are many more rules surrounding Solo 401(k)s than there are SEP IRAs, so you need to be careful.

This is where the help of a trusted financial planner is going to be incredibly valuable. They can sit down with you and look at your specific situation and work with you to choose a self-employed retirement account that will allow you to maximize what you can save.

Simple IRA: These retirement accounts are best utilized by those who know they want to expand and take on employees. You can start out as a one-person shop, but as you expand, you can continue to utilize the Simple IRA. You will be required to match employee contributions, up to 3%. Annual contributions are capped at $12,000

Don't Forget Your Safety Net

Another key to retirement planning for self-employed individuals is an emergency fund.

It can sound a little odd to throw this in with retirement needs, as emergency funds are supposed to be liquid accounts that can be used at any time to avoid a financial crisis. But that's exactly why they're so important, especially to people who are dealing with the fluctuating, variable income that comes with self-employment territory.

Be sure you're building up your emergency fund if you haven't already. Even contributing a little each month will add up over time. You'll be extremely grateful you have this safety net to fall back on if your work slows down, business gets rough, or new clients are hard to find. You can rely on your emergency fund to get you through the hard times rather than dipping into your retirement accounts and taking from your nest egg.

Reach Out and Ask for Help

Self-employed retirement accounts with all their rules and limits can be confusing. If you need help sorting through the options to determine which one is right for you, reach out to one of our financial planners via our Find an Advisor page.

Retirement planning for self-employed workers is definitely tricky. But it can be done and if you work for yourself, a happy, successful retirement is completely within your grasp if you're willing to save now - and ask for help when you need it.