Heritage Financial Planning

The Best Retirement Plans for the Self-Employed

February 16, 2022

If you're self-employed, then you already know that you're on your own when it comes to the benefits enjoyed by those employed by a company. Between getting a business off the ground and dealing with its daily challenges, it's very common for those who are self-employed to skip planning for their retirement. In fact, many business owners delay planning because of the following mindsets: 

1. "Retirement planning can come later."

woman working at desk with computer and papersIt can be easy to just shove off this financial task for a later date.  After all, you have more important things to pay attention to at the present moment.

2. "I'll just sell the business."

Selling the business is one of the most common retirement plans, but also one of the worst. While your business may have a lot of value today, it may not have as much in the future. It's impossible to predict how much it will fetch years from now, or if circumstances will force you to sell at an inopportune time.

Think of retirement planning as an additional investment strategy that complements your business. All of the retirement plans listed below are tax-deferred accounts that can save you thousands of dollars a year while you're growing your business, and provide a steady source of funding to you years down the road.  

1.  A Traditional IRA

IRAs have been around for years; they were one of the first tax-deferred retirement plans that the IRS introduced. They make up the cornerstone of many people's retirement plans, mainly because of the ease of investing in this type of plan. IRA accounts can be set up with just about any brokerage in a matter of minutes, and it's possible to invest in just about anything, including real estate or stocks. 

Contribution Limit: Individuals under 50 years of age can put aside $6,000 in 2022. This amount increases to $7,000 if they are 50 or older.

Tax Advantage: All contributions to a traditional IRA are tax-free. That is, you'll be able to deduct the amount of your contribution from your total income on your income tax statement.  For many self-employed persons, traditional IRAs are a perfect way to reduce their tax burden in high earning years.  By placing money into one of these accounts, the tax advantages alone guarantee at least an automatic 10% return on the money, with some business owners able to get a tax advantage of 30% or more.

2.  A Roth IRA

Roth IRAs are a little more modern than the traditional IRA, but they have some very useful tax advantages.  

Roth IRA text on top of United States dollar bills Contribution Limit: Individuals under 50 years of age can put aside $6,000 in 2022. This amount increases to $7,000 if an individual is 50 or older.

Tax Advantage: All money that goes into a Roth IRA is taxed, but all withdrawals from the account are tax-free. In recent years, changes have been made that allow funds from these accounts to be withdrawn to pay for the initial purchase of a primary residence and some higher educational expenses.  

For a self-employed person, that means these accounts can function as a long-term savings plan with high-potential for significant gains. Not paying taxes in the future means that it will be possible to withdraw funds from this account in years when your business is doing well without paying a higher level of taxes.

3.   A Solo 401(k)

People who have worked for a company before are probably familiar with how a 401(k) works.  These accounts are very similar, but they are set up for an individual.  Note that these accounts cannot be set up for employees of your business; you will need to set up a 401(k) plan if you want to include any employees.

Contribution Limit: Contribution limits for 2021 were high; the lesser of $58,000, with an additional $6,500 catch-Solo 401(k) written on a black piece of paper on desk with 100 dollar bill up contribution or 100% of earned income. For 2022, it's even higher; the lesser of $61,000, plus a $6,500 catch-up contribution or 100% of earned income. The total limit on the income that can be used to factor your contribution is $305,000 in 2022.

Tax Advantage: Contributions to these accounts are made before income taxes are taken out.  After age 59 ½, all withdrawals are taxable. For this reason, these accounts are a great way to move large amounts of money in years when the tax burden will be too high, and pay taxes in later years when you believe your tax burden will be lower.

Because of the very high contribution limits, these accounts are often recommended to self-employed persons who are selling a large portion of their business or who are expecting a large amount of profit. They are often used to spread out a tax burden from these high earning years over several later years.

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Written By: Heritage Financial Planning Team

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