When you are self-employed, you do not have access to an employer 401k plan with matching contributions. This doesn’t mean you can’t save for retirement. These self-employment retirement options will help you save for your future years and save money at tax time too.
#1: Traditional IRA
If you want a tax break today a traditional IRA is a good option. You can contribute up to $5,500 each year to reduce your taxable income. Assuming you make $40,000 in 2017 and contributed $5,500 to your traditional IRA, your taxable income would actually be $34,500 because of the IRA tax deductions.
Your contribution will grow tax-deferred meaning you won’t pay an annual capital gains tax each year, but, you will pay taxes when you finally withdraw your money in retirement. If you plan to be in the same or lower tax bracket in retirement as your current tax bracket, you won’t pay any more in taxes when you finally do pay them.
With a traditional IRA, you can invest in any type of investment. This means you can buy individual stocks, mutual funds, ETFs, REITs, bonds, options, currency…
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#2: Roth IRA
If you want your contribution to grow tax-free, the Roth IRA is a better option. When you pay taxes is the primary difference between a Traditional and Roth IRA. This is because Roth contributions are made with post-tax dollars. You pay the tax today so you don’t have to pay the tax later.
This is one reason I like investing with a Roth IRA. There are no surprise tax bills in retirement. All the money in your Roth account is yours because Uncle Sam already took his cut.
Like Traditional IRAs, you can invest in any investment option your brokerage offers. Annual contribution limits are $5,500 and Roth contributions are non-deductible because they grow 100% tax-free.
Whether you use a Traditional IRA or Roth IRA (or both!), there are IRA income limits that prevent you from making contributions if you have a high salary.
#3: SEP IRA
A third option is a Simplified Employee Pension (SEP) IRA.
This is an option to consider if you are a sole proprietor (1099) or own a partnership, S-Corporation, C-corporation, or LLC.
A SEP IRA is a bigger & better version of a Traditional IRA. All contributions are tax-deferred. For 2017, you can contribute up to 20%-25% of your pre-tax income or $53,000, whichever is lower.
If you have employees, you can also make employer contributions to employees.
Most brokerages offer SEP IRAs and they are an affordable retirement plan with very few administrative fees. And, there are fewer tax forms than other self-employed retirement plans if you plan to make employer contributions or extend the plan to your current employees.
#4: Individual 401k
This is self-employment retirement option goes by several different names. It’s known as an Individual 401k, Solo 401k, and a Self-Employed 401k.
This plan is also very popular among established freelancers that incorporated their business to separate their personal assets from their business assets. An individual 401k is arguably more popular than a SEP IRA because it has higher contribution limits and allows catch-up contributions for those older than 50.
You might also this option because some brokerages offer individual 401k plans with “Roth” post-tax contributions in addition to traditional pre-tax contributions. Remember, with a SEP IRA you can only make pre-tax contributions.
Individual 401k plans allow you (the employee & employer) to contribute up to $54,000 in 2017. Employee tax-deferred contributions can only be $18,000 per year which is the same contribution limit as an employer 401k plan. Plus, you can make employer profit-sharing contributions up to 20% of the self-employment income or $54,000 including the employee contributions.
#5: SIMPLE IRA
The final option is a SIMPLE IRA. This is a pre-tax option and available to small businesses with fewer than 100 employees.
Employees can contribute up to $12,500 each year and those 50 or older can contribute up to $15,500 annually. Employers make offer a matching contribution up to 3% each year per employee.
One downside to this retirement option, from an employer’s viewpoint, is that you are required to make a matching contribution even if you don’t earn a profit for the year. With some of the other plans, like the SEP IRA, contributions are optional.
Summing Up All the Self-Employment Retirement Options
If you don’t have an employer 401k, you might have to work a little harder to save for retirement, but, you do have several tax-advantaged options. If you are just getting starting and don’t have much extra money to invest, a Traditional or Roth IRA is a good option. Once your earnings accelerate or you hire employees, a SEP IRA or Individual 401k are very popular options due to their flexibility.