In some respects, self-employed workers have a sweet deal. They can work when and where they want, doing what they love. But when it comes to saving for retirement, these workers struggle more than those with a 9-to-5 job. Just 56% of independent workers said they were actively saving for retirement, compared to 72% of traditional employees, according to a recent T. Rowe Price survey. Only 21% of the independent workers surveyed reported any access to an employer-sponsored retirement plan of their own.
Fortunately for the self-employed, there are other types of accounts they can use to set aside money for their futures. Here are some of the most common ones, along with tips to help you free up more cash for savings.
Retirement savings accounts for the self-employed
Self-employed people may save money in a traditional or Roth IRA, a SEP IRA, a SIMPLE IRA, or a solo 401(k). Here’s a look at each of them.
Traditional or Roth IRA
Anyone can open a traditional or Roth IRA. Traditional IRAs are tax-deferred, so your contributions reduce your taxable income this year, but then you pay taxes on distributions in retirement. You pay taxes on Roth IRA contributions this year, but afterward, the money grows tax-free. The traditional IRA makes sense if you believe you’re in a higher income tax bracket today than you will be in retirement while the Roth makes more sense if you’re just getting your business off the ground and you anticipate being in a higher tax bracket in retirement.
You may contribute up to $6,000 to an IRA in 2019 or $7,000 if you’re 50 or older. This limit is for the total contributions to all of your IRAs. You cannot contribute $6,000 to a traditional and $6,000 to a Roth IRA.
Simplified employee pension (SEP) IRA
A simplified employee pension (SEP) IRA is an alternative to the traditional IRA for self-employed workers who feel the regular IRA contribution limits are too low. With a SEP IRA, you can contribute up to the lesser of 25% of your net earnings — your income minus business expenses — or $56,000 in 2019. These contributions reduce your taxable income this year, but you pay taxes on distributions in retirement.
The catch is, if you have qualifying employees, you must contribute the same percentage of their income to their retirement savings account as you do to your own. If you contribute 10% of your income to your SEP IRA, you must also contribute 10% of qualifying employees’ income to theirs. A qualifying employee is one who is 21 or older, has worked for you for at least three of the last five years, and has earned at least $600 from you during that time. Because of this, a SEP IRA may not be your best option if you have employees.
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA can be a better option than a SEP IRA if you have employees. Legally, you must put some money toward your employees’ retirement savings, but you can choose if you want to pay a flat 2% of their income whether they make any contributions or not or a dollar-for-dollar match on the first 3% of your employees’ income. Employers may reduce the 3% match, but not below 1% or for more than two years out of five. Of course, if you don’t have employees, you don’t need to worry about this.
Employees may contribute up to $13,000 to a SIMPLE IRA in 2019, and adults 50 and older may make up to $3,000 in catch-up contributions each year. These contributions reduce your taxable income this year, but then you pay taxes on distributions in retirement.
Solo 401(k)
A solo 401(k) is another option if you have no employees. It’s similar to a regular 401(k) except it has higher contribution limits because you can contribute as employee and employer. Your employee contribution limit is the same as it is for traditional workers. You may set aside up to $19,000, or $25,000 if you’re 50 or older, in 2019. Your employer contribution is up to 25% of your net earnings, though your total solo 401(k) contributions cannot exceed $56,000, or $62,000 if you’re 50 or older.
You may choose a traditional or Roth 401(k), and you can open a solo 401(k) with any brokerage firm as long as you have an employer identification number.
Ways to boost your retirement savings
Having the right accounts is important, but they’ll do you little good if you can’t afford to contribute to them. This can be challenging if business is slow or sporadic and you cannot save as much as you’d like to each month. In that case, plan to set aside a smaller amount when work is slow and a higher amount when it’s booming. You could also try gradually increasing your savings over time. Aim to increase your monthly contributions by 1% of your average salary every year.
If your savings are way off track, consider working some overtime to get more money coming in and then put the extra toward your retirement savings. You could also look for ways to reduce your living expenses, like canceling subscriptions you no longer use and limiting how often you go out to eat.
Saving for retirement is challenging for everyone, and especially for the self-employed. But by making it a priority and taking advantage of the special accounts designed to help independent workers save for their future, you can give yourself a good shot at a happy retirement.
