One For The Money

• Retirement considerations in self-employment [01:19]
• Deciding when to be taxed on retirement savings [02:45]
• Advantages of Roth vs. traditional IRAs [04:51]
• SEP IRA and solo 401k [05:35]
• The Personal Pension Plan [10:35]
• W2 employees without access to 401k [14:50]

Many Americans dream of being their own boss. Self-employed professionals such as sole proprietors and independent contractors are living out that dream. While they have the opportunity to reap the rewards of being their own boss, they also assume all of the risks. One of those risks is saving for retirement, which is entirely up to the individual since there isn’t a company to provide a matching contribution.

A self-employed individual has several options available, and choosing the right one will depend on income. The simplest option is to have an individual retirement account. These come in two varieties, Traditional and Roth. These types of accounts are only taxed once with ordinary income taxes. With a traditional IRA, taxes are applied in retirement, and with a Roth, taxes are applied now. 

Deciding when to be taxed is based on income level. If your income is on the lower side, I typically recommend you pay the income tax now and contribute to a Roth. If you’re in a higher income bracket and expect to have a lower income in retirement, you’ll want to wait to pay your income taxes then. There are a lot of factors to consider, so it’s recommended that you check with a certified financial planner.

A solo 401k has the advantage of allowing higher contributions with smaller incomes. Also, more can be contributed to a solo 401k via profit-sharing contributions from your business. Another advantage is having the option of traditional or Roth. Something to keep in mind is that while a solo 401k can have a loan taken out on it, I’d only recommend borrowing from it to avoid bankruptcy. 

All these features come with an additional administration cost. A solo 401k is subject to IRS ERISA rules, so a third-party administrator is required to help manage the plan paperwork and annual filing requirements. The contributions for a solo 401k have to be established within the same tax year they’re made. The employee contributions need to be made within the year or the first few weeks of the following year.

Those who are W2 employees without access to 401k plans may be wondering what their options are. Unfortunately, retirement plans are similar to healthcare; employers usually provide the best options. Your next best options are either a traditional IRA or a Roth IRA. After maxing out contributions for the year, a further option would be to save in a non-retirement account. However, with a non-retirement account, you’re taxed multiple times. Taxes are paid on the money invested, which was already subject to income tax. Then, if you’re receiving dividends and interest, taxes will be paid on them as well. Finally, when an investment is sold for a gain, taxes will be paid then as well. 

Non-retirement accounts have the advantage of paying long-term capital gains if the investment is held for more than a year. Another advantage is that the funds are accessible any time instead of waiting until age 59 and a half. Also, if there are losses in a non-retirement account, they can be offset against gains to mitigate taxes that would have to be paid. Overall, there are a lot of factors to consider, which is why I recommend speaking with a certified financial planner who will evaluate your entire financial picture when making a recommendation.

• Employee Retirement Income Security Act (ERISA) | US Department of Labor