Nearly 40% of Americans participate in the “gig economy.”1 This workforce includes all kinds of self-employed consultants, freelancers and contractors, plus temporary and on-call workers.
Self-employment is an appealing career path for many people, but it doesn't come with a built-in retirement plan.
“Self-employment is a double-edged sword,” says Joni Meilahn, vice president and product manager for U.S. Bancorp Investments. “With greater freedom and flexibility also comes greater responsibility. You don’t have the support of an employer-sponsored retirement plan to keep you on track. And, if your self-employment turns into a small business with employees, you become the source for not only your retirement plan but theirs as well.”
Retirement planning while being self-employed starts with a basic understanding of how much you can afford to save for retirement. Look at both your cash flow and your business expenses for the year to see how much you can comfortably put away each month.
Keep in mind the long-term nature of saving using IRS tax-qualified plans since there are penalties and taxes on withdrawals prior to age 59 ½. “Working with an accounting professional can really make a difference here,” says Meilahn. “That person can help you decide how best to report revenue and expenses in a way that’s both accurate and beneficial to your business.”
After you have a sense of how much you can afford to put away for retirement, it’s time to find the specific, tax-qualified plan for you. Two tips before you get started:
1. Understand the IRS tax forms for your business
The structure of your business will determine which income tax forms you’ll need to file each year, and how your taxable income gets reported that provides the correct income upon which to base retirement plan contributions. Qualified retirement plan contributions provide valuable tax deductions that help reduce your overall taxes.
Are you a small business owner with employees? A contract worker out on your own? The answers determine how the IRS will tax your earnings. Check out these guidelines from the IRS to see which filing forms you’ll need, depending on your business structure.
2. Choose a tax-qualified retirement plan that fits your criteria
You’ve laid the groundwork by following the correct IRS reporting structure for your business. You know how much you’re prepared to contribute to your retirement. That means you’re ready to decide which tax-qualified plan to use. Each retirement plan comes with its own set of rules and contribution limits.
Each retirement plan comes with its own set of rules and contribution limits, so keep in mind that “best for you” really depends on your personal situation.
Following are five common tax-qualified retirement plan options for self-employed individuals and small business owners.
1. Traditional or Roth IRA
An individual retirement account (IRA) is a good option if you’re saving less than $6,500 for the year, or if you’re leaving a job to start a business. When you have no other qualified retirement plan, IRA contributions are fully tax deductible. Learn about the differences between a traditional IRA and a Roth IRA.
2. SEP IRA
Consider opening a Simplified Employee Pension (SEP) IRA if you have few or no employees and aren’t sure if you’ll be able to contribute every year. A SEP IRA follows the same rules as traditional IRAs; contributions are tax deductible, reducing your taxable income.
3. Solo 401(k)
A Solo 401(k) is essentially an individual 401(k) for solo business owners or self-employed individuals with no employees. This option, sometimes called a self-employed 401(k), can also include your spouse as an owner to maximize household contribution potential.
4. SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a good option if you’re self-employed or own a larger business that has up to 100 employees. In both instances, think of yourself as both the employer and employee for contributions to your own account.
5. Self-Employed Defined Benefit Plan
A Defined Benefit Plan is a good option if you’re self-employed or a small business owner, have consistent, high income and want to save a lot for retirement on an ongoing basis.
Choosing which plan is right for you and your business is a personal choice, but one you can ask for guidance from your accountant or financial professional. “When you understand which level best fits for you, and when it might be appropriate to move up the retirement plan pyramid, everything is a lot easier,” Meilahn says.
When you’re self-employed, planning for retirement needs to be a self-driven pursuit. Whether you’re a new gig worker or have chosen a freelance or contracting gig as your second act in life, it pays to know what your options are so you can create a solid retirement fund that will help you build a brighter future.
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