“SELF EMPLOYED” RETIREMENT PLANS
Are you Self Employed as a Stylist or Aesthetician in the Professional Salon Industry? Did you know you have many of the same options to save for retirement on a tax-deferred basis as employees participating in company plans?
The category of the “Self Employed” American workforce is not doing too well these days at retirement planning. A study showcasing that only 36% of people who work for themselves say they have saved regularly for their personal retirement. This is recorded, according to a recent survey conducted by the Transamerica Center for Retirement Studies, compared with 54% of people who work for companies or other people. The “self employed” is a category that ranges from job to job, or the Gig economy workers who book their jobs online, to small business owners. They are one of the fastest growing segments of the workforce. Unfortunately the freedom they get from being in charge of their lives is often accompanied by a volatile income stream that is not consistent, making it harder to predict how much of their income to put aside for their retirement plan and even harder to predict how much money they will have at their actual retirement. For many self employed people, working longer at their career is their ultimate retirement plan, even though this does take into consideration health issues and the costs associated with these types of challenges. More than one half of this category say they expect to retire after age 65 or possibly never.
When you work for yourself, saving for retirement can be a struggle on the financial, as well as the mental side. It can seem like there will be moments where you will not have even a spare penny to set aside for a long period of time. The key is to change your mindset and how you personally think about life issues such as these. Because of their fluctuating income streams, this group of workers cannot budget the same way that a non self employed person can. It helps to think about retirement savings in terms of percentages, rather than dollars, when it comes down to funding these plans. Saving a set dollar amount can cause a person to save too little in high income months, and more than you can afford in lean months. A key point to consider is that falling behind on quarterly tax payments can derail any savings plan. It is critical to understand that you properly work your tax payments into your budget. Make sure you factor in your income and your “self” employment taxes. This avoids the pitfall of spending dollars you do not have and need for your business. If you are self employed, this does not mean you have fewer options to consider in deciding where to invest for retirement. The real challenge is trying to figure out which plan makes the most sense to use. Here is a breakdown of some of the most popular with their benefits, so that you can select a plan that offers you what you need for your long term planning and your personal retirement plan.
There are five retirement plans for self employed individuals that can help ease the strain by reducing your taxable income while putting money away for retirement. Which plan is best for you is dependent on multiple factors, including your income and age, whether you have employees, and your intentions for how you fund your retirement plan.
5 Retirement Plan Options for the Self-Employed (Stylists and Aestheticians)
Traditional or Roth IRA
Best for: Everyone with earned income, though Roth IRAs have income limits. An IRA can be used in combination with other plans, but the amount of traditional IRA contributions you can deduct from your income taxes might be reduced. If you’re leaving a job to start a business, you can also roll your old 401(k) into an IRA.
IRA contribution limit: $5,500 in 2017 (plus $1,000 catch-up contribution for those 50 or older).
Tax advantage: Tax deduction on contributions to a traditional IRA; no immediate deduction for Roth IRA, but withdrawals in retirement are tax-free.
These are individual plans. If you have employees, they can set up and contribute to their own IRAs.
Maybe you like to keep things simple. Or maybe you’re just starting your career — 1 in 4 millennials is an entrepreneur, according to the Kauffman Foundation, a nonprofit that focuses on entrepreneurship — and the reality that you don’t have a great deal of money to put away. In that case, an IRA might be a good option.
It’s probably the easiest way for self-employed people to start saving for retirement. You simply open an IRA with someone like myself and report contributions on your tax return each year. There are no special filing requirements, and you can use it whether or not you have employees.
We have given in-depth coverage to the differences between traditional IRA’s and Roth IRA’s, but here’s a quick rundown of the basics:
A Roth IRA doesn’t reduce your taxes today, but after age 59½ you can pull out your money tax-free
A traditional IRA nets you a tax deduction on contributions for the year you make them, but the money is taxed as income when you pull it out — again, after 59½
Both accounts are designed to remain untapped until retirement, and there are penalties, with few exceptions, for early withdrawals. But the Roth IRA rules are more flexible — you can remove your contributions, but not your investment earnings, without penalty at any time.
The tax treatment of a Roth IRA might be ideal if it is in the early phase for your business, in other words, you’re not making much money, because your tax rate is likely to be higher in retirement, when you’ll be able to pull that money out tax free.
Pros of a Solo 401(k):
High contribution limits. Because you are both the employer and the employee, you can contribute more to a Solo 401(k) plan than you can to other retirement plans. As an employee, you can contribute up to $18,000 for the year (plus up to $6,000 in catch-up contributions if you’re over 50). As in a traditional 401(k) your contributions are made with pre-tax dollars. Then, as the employer, you can contribute up to 25% of your business’s total earnings (or 20% if you are a sole proprietor or single-member LLC) on top of the employee contribution, until you reach a combined total amount of $53,000 (or $59,000 including catch-up contributions). Plus, employer contributions are deductible as a business expense.
Contribute double. With a Solo 401(k), you can hire your spouse and let them participate in the plan. Your spouse can contribute up to $18,000, and you can put in the typical employer contribution up to a total amount of $53,000. Your spouse can also make catch-up contributions, if eligible.
Tax deferred growth. As in a traditional 401(k), your contributions are pre-tax, and you pay tax on withdrawals.
Flexibility. You can put in as much, up to the limit, or as little as you want from year to year.
Cons of a Solo 401(k):
Paperwork. You must file a report with the IRS annually if you have at least $250,000 in your account.
Not open to everyone. You can open a Solo 401(k) only if you have no employees other than your spouse.
Bottom line: These plans are fabulous for self-employed people with no employees (other than a spouse) because of the high contribution limits, tax-deferred growth and flexibility in contribution amounts.
Smart strategy: If your self-employment income is not very high, you could use your low tax bracket to your advantage. In this case, you might choose to open a Roth Individual 401(k). With a Roth 401(k) you put in after-tax dollars, and they grow tax-free. Assuming that your tax bracket will be higher down the road, this strategy will save you money. Additionally all the funds you withdraw in the future would be tax-free.
SEP IRA – Simplified Employee Pension
Pros of a SEP IRA
Ease of creation and maintenance. All it takes is some basic paperwork to set up, and no annual reporting to the IRS is required.
High contribution limits. You can contribute up to 25% of the W-2 income you pay yourself, or just under 20% of your Schedule C net income, up to $53,000 for 2016. This is great because your contributions can grow with your profits.
Tax-deferral. You benefit from tax-deferred contributions and growth until you begin withdrawals. In general, you can start taking money out at age 59½. You don’t have to start withdrawals until age 70½.
Cons of a SEP IRA:
Contributions come only from the employer. If you have employees, you must include them all in the retirement plan, and you cannot contribute a higher percentage to your own account than you do to theirs. This can get expensive.
Bottom line: These plans are best for self-employed workers who have very few or no employees and want flexibility in the amount they put away (for example, they want to tie contributions to profits).
SIMPLE IRA – Savings Incentive Match Plan for Employees
Pros of a SIMPLE IRA:
Ease of creation and maintenance. Just as with the SEP IRA, it only takes some basic paperwork to open an account. The annual maintenance paperwork is also simple.
Moderate contribution limits. You can contribute almost all of your net earnings, up to $12,500, into a SIMPLE IRA each year (plus an additional $3,000 if you are age 50 or older).
Deductible expenses. Matching contributions are deductible for the employer as a business expense.
Cons of a SIMPLE IRA:
Lower contribution limits. The limit is significantly lower than for a SEP IRA, Solo 401(k) or defined benefit plan (see below).
Possibility of mandatory matching contributions. As the employer, you can choose to make either a fixed 2% contribution to employee accounts, or match employee contributions of 1% to 3% of total pay. Most employees do not contribute to such plans, so it is unlikely that choosing to match would cost you much.
Lots of rules. For two years after your initial contribution, you cannot transfer your SIMPLE IRA into any other retirement plan. In addition, if you are under age 59½, any distribution you take in the first two years will be subject to a 25% penalty.
Contributions count against 401(k) contributions. If your self-employment is an on-the-side gig and you have a 401(k) from your other job, any contributions you make to your SIMPLE will count against the $18,000 you could otherwise defer into your 401(k) for that year.
Limited to small businesses with fewer than 100 employees. However, this is not an issue for most self-employed Millennials.
Bottom line: These plans are particularly attractive for small businesses with lots of employees (who usually don’t contribute, hence no match or employer cost). At the same time, the employers can get a 3% match based on income.
Defined benefit plan
These plans go back to the old-school pension plans that our grandparents’ generation had, and are actually wonderful for certain self-employed workers.
Pros of a defined benefit plan:
Very high contribution limits. How much you can contribute depends on your age, but you could potentially put away more than $100,000 per year for retirement.
Can be combined with other plans. You can contribute to a defined benefit plan while simultaneously contributing to a 401(k) or SEP IRA.
Lower taxes. Contributions can be written off as business expenses, thereby reducing your taxable income.
Tax deferral. Growth of contributions is tax-deferred.
Cons of a defined benefit plan:
Expensive. Defined benefit plans are complicated to set up and somewhat costly to run.
Little wiggle room. You commit to funding the plan at a certain level, and you are stuck with that even in a year when money is tight.
You must offer this plan to any employee. You must make contributions on their behalf. This can get very expensive.
Bottom line: This plan is great for solo self-employed workers who have high, stable incomes and want to put a lot away for retirement.
Saving for retirement by contributing to one of these plans reduces your taxable income and can even bring you to a lower tax bracket. This will save you a lot of money in the short term, while benefiting your financial stability for the long term.
Your financial future depends on how you address your individual circumstances. There is no one way of preparing for the future that is right for you and your family, but there are common elements. That is the reason you need the help of a licensed financial consultant that can assess your particular needs and help you work towards a sound financial future. It all begins with a good understanding of how these five retirement plans can benefit you and your family.
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Here is my Call to Action. Contact me at 213 276 4588 for a short conversation to see if our services can make a difference in your financial life. You have nothing to Lose and everything to Gain. Time can be your worst enemy or your greatest ally. No matter where you are in life or in building a financial strategy, the key is to begin saving as quickly as possible. The sooner you begin, the less money you need to set aside to create a solid financial future.
The Author, James Hobart, has a fifty nine year career behind him, ten in the U.S. Military and forty nine in the Professional Beauty Industry as an industry executive at every level, with certification in hypnotherapy and a Life and Health license. His insight and experience has helped many companies and individuals with their growth and development over the years. His books, Happiness Is Your Birthright, and Salon / Spa Retail – The Lost Revenue Stream, and his Blog: http://jameshobartmarketing.com, support his philosophy on life and are practical sources to create positive change throughout one’s life.
His support of the global Wellness movement and its eight dimensional model is defined by a focus on three income streams, Financial Consulting with a world class financial services company, a Certified Hypnotherapist with a practice in Ventura, CA, and a Wellness Coach with the largest Consumer Direct Wellness Marketing Company in North America. More information is available at http://makegreengogreen.com/jameshobart or http://melaleuca.com/jhobart