Many people save for retirement primarily through employer-sponsored plans such as 401(k)s. However, this situation becomes complicated when individuals are self-employed because their access to tax-advantaged accounts is different.
Since self-employed individuals have so much to worry about in terms of day-to-day management of the business, planning for the future may not be a priority. Unfortunately, this can cause individuals to scramble as they get closer to retirement.
If you are self-employed, it is still important to think about building wealth early in your career and create a strategic plan for retirement. That way, you will not find yourself needing to push off retirement down the line. Some tips to keep in mind when strategizing for retirement include:
1. Open a Solo 401(k).
One of the key retirement savings options for self those who are-employed is the Solo 401(k), which has a contribution limit of $57,000 annually. You can choose between a traditional or Roth account.
With a traditional account, contributions are made with pre-tax money, but are taxed when you make withdrawals in retirement. With a Roth account, you invest income that has already been taxed, but then do not owe taxes in retirement. This account has many of the same benefits as an employer-sponsored one and should be a cornerstone for retirement saving.
Also, it is worthwhile to note that money can be accessed from a Solo 401(k) prior to reaching retirement age through a loan feature. As long as the rules are followed, the loan is not a taxable event. This feature provides some flexibility for self-employed individuals who may be looking for more liquidity in their savings.
2. Fund a Roth IRA.
For most people, a traditional Solo 401(k) makes the most sense. This is because most people will likely be in a lower tax bracket in retirement than they are during their working years. Therefore, you will pay less taxes overall by a lowering your taxable income via traditional 401(k) contributions. However, you should still diversify your retirement savings with a Roth account.
In addition to a traditional Solo 401(k), you can open a Roth individual retirement account (IRA), which also has tax advantages. With this account, you can invest up to $6,000 annually or $7,000 if you are 50 or older.
Having a Roth account is beneficial since it can prevent you from landing in higher tax brackets when you are retired. For example, if taking money out of the Solo 401(k) would bump you into the next tax bracket, you could take it from the Roth account instead and avoid the additional taxes. Opening a Roth account expands possibilities for funding retirement.
3. Pay yourself first.
One of the traps that self-employed individuals can fall into is putting all profits back into the business. To ensure you have money to save, you need to pay yourself first. When you begin doing this, it may be a challenge, but it is the best way to guarantee your own financial future.
Create a separate account for these “paychecks.” The initial amount may be small, but be sure to increase it over time as the company becomes more stable and successful.
You should also create a second, so-called “sacred” account that is not touched. This account is solely for wealth building and should be part of the payment to yourself. With this setup, you have forced and automated savings that can be funneled into retirement accounts or other investments.
4. Treat the business as an asset.
Your business is an asset and can be part of your overall nest egg. While it is important to build wealth outside of the business, expanding the company can also be seen as an investment for retirement.
Have an exit plan in mind so that you can monetize the company down the line when retirement approaches. For many self-employed individuals, the business becomes a primary source of income in retirement, so it is important to think of it as an investment and treat it as such.
Great retirement planning involves several different strategies, so you may also want to consider stocks and real estate aside from tax-advantaged retirement savings accounts. Just be sure to count your business among these different strategies and invest back in the company once you have paid yourself.
5. Set firm budgets.
You should have budgets for both yourself and your business that are realistic. With a budget, you can plan better for the future and get a sense of where you will likely stand down the road. While it may seem difficult to budget when cash flow is uncertain, this is key to success.
Part of budgeting involves setting aside emergency savings to help survive any rough patches both personally and professionally. Having an emergency fund tucked away makes your business stronger and also reduces the risk of needing to dip into retirement savings when financial situations arise.
Your budget should also include necessary insurance products. When you are self-employed you have unique risk exposure and should protect yourself as much as possible. Finance professionals can help you identify the best insurance products for your needs.