More and more people are entering the world of entrepreneurship. Being self-employed is appealing to many, offering freedom and control of your own future, as well as unlimited income potential. But it also has its challenges, one of which is retirement planning.
In this guide, you’ll find out how to prepare for retirement as a self-employed individual.
People who work for a company or in the public sector usually have the benefit of company-matched 401Ks or pension plans, making saving for retirement automatic. Self-employed people, on the other hand, have to be proactive and create their own retirement plans. They also have to be disciplined enough to allocate some of their income to savings vehicles.
Planning and saving need to start early and should be based on your specific retirement goals, such as your ideal retirement age and your retirement lifestyle goals.
Understanding Retirement Plan Options for the Self-Employed
Several different types of retirement account options are available for self-employed people.
Traditional or Roth IRAs
Individual retirement accounts (IRAs) are the simplest retirement savings option. Traditional IRAs are funded with pre-tax income and grow tax-deferred until retirement. Contributions to the IRA are tax deductible in most cases, up to specified limits, which for tax year 2023 are $6,500 annually for people under 50 and $7,500 for people over 50. Some exceptions to the deductibility rules do apply, so you’ll need to check your eligibility.
IRA contributions cannot be distributed without a penalty until age 59 1/2. When withdrawals are made after that age, they become taxable income. Distributions taken before age 59 ½ are subject to income tax plus a 10% penalty.
IRA contributions can be invested in most types of investment vehicles, including stocks, bonds, and mutual funds. There are a few exceptions, which include collectibles and life insurance policies.
A Roth IRA has similar rules, but contributions are not tax deductible. However, the earnings of the IRA are tax-free and distributions taken after age 59 ½ are also tax-free.
Solo 401K
If you’re self-employed and have no employees, you can contribute to a solo 401K, both as an employer and as an employee. Contributions are tax deductible and grow tax-deferred until retirement, and then withdrawals are taxed. Contribution limits are much higher than with IRAs: $66,000 annually for those under 50 for tax year 2023, and an additional $7,500 for those over 50.
Of those totals, $22,500 can be contributed as an employee, and 25% of your net income can be contributed as an employer up to the $66,000 total contribution limit.
SEP IRA
A simplified employee pension (SEP) IRA can be established by an employer or a self-employed person. If you don’t have employees, you can make tax deductible contributions to the SEP IRA, and contribution limits are higher than those of traditional IRAs. If you have employees, you can make contributions on their behalf into individual SEP IRAs, and those contributions are also tax deductible.
Contributions made on behalf of employees are discretionary, so you can change the contribution amounts at any time, as long as your contribute equally for all eligible employees.
Contributions are limited to the lesser of 25% of income or $66,000.
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA allows both employee and employer contributions. As the business owner, you can make your own contributions both as an employer and an employee. The employee contribution limit is $15,500 and the employer contribution limit is 2% of your net earnings
Succession Planning
Timeline Planning
First of all, you’ll need to determine when you’ll transfer the business to your successor. Presumably, you have a target retirement age, so you’ll need to determine your retirement date. You also should have a contingency plan for what will happen to the business if you die or become disabled before that date, or what happens if you decide to retire early.
Choose Your Successor
Choosing your successor may be a difficult decision, particularly if you have multiple family members involved in the business or who are interested in taking over the business. However, your decision should be a practical one. You’ll need to choose a person or persons who are qualified to manage the business so that the business has a better chance of survival after you retire. This will also protect the residual income that you plan to take from the business.
You can choose to transfer ownership to multiple family members or key employees, but you’ll need to determine how that ownership will be divided. You should also determine what the key roles of each person will be. For example, perhaps one person is most qualified to handle the finances of the business, while another is more skilled at operations.
You can create an organizational structure for your business that will make these future roles very clear.
Document Your Processes
Your successor or successors are going to need to know how you’ve made the business successful, so basically, you should draw up a blueprint for managing the business. You need to document your operational processes, your key personnel, your marketing strategy, your financial processes, and your human resources processes.
You’ll also want to highlight your keys to success. What has helped you most in growing your business to this point?
Create a Transition Plan
Create an Ownership Transfer Agreement
Determining Your Retirement Needs
Strategies for Boosting Retirement Savings
Boosting Retirement Income
Rely on Professionals
Planning for retirement, whether you’re self-employed or not, is not a do-it-yourself project. A financial planner is essential to creating a comprehensive financial and retirement plan, and a plan to meet your shorter-term financial goals. You should look for a financial planner that also has experience in succession planning so that they can help you through that process.
An attorney is also a necessity when creating your succession plan and documents.
Conclusion
The most important thing for you to take from this article is that the time to start retirement planning is now. It may seem as though retirement is a long way away, but to achieve your retirement goals, you have to have a long-term plan. You also have to teach yourself to be disciplined about saving and follow the advice of your financial planner. If you take the right steps, you can spend your retirement years exactly how you choose.
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