I didn’t want to work a nine to five so I started my own business and now I work 24/7.
While a cheesy cliché, there is some truth to that. I have now owned my own business, worked part time for a company, and worked full time for huge multinational corporations. While I objectively work less than I did when I owned my own business, the freedom to set my own hours, my own clients, and control my own salary is one I would like to get back to.
One of the things that is challenging for any small business owner or freelancer is managing benefits.
While health care is an important part of this, it is also a segment I know very little about.
What I want to talk about today is saving for retirement.
Saving for retirement, while working full-time for most major companies is quite easy. The formula usually looks something like this:
- Start working
- Receive sign up link to enroll in 401k
- Learn about employer match
- Select how much you want to contribute every paycheck
- Choose investment allocation
Congratulations! You’re saving for retirement.
Follow three simple steps and you are almost guaranteed to have enough money to retire.
- Put away enough money every paycheck
- Choose an appropriate asst allocation
- Continue to do this for the next 40 years
Easier said then done. Unfortunately, for most business owners it can be even more complicated. The options are more numerous and choosing the right one or ones can seem daunting.
business equity
Depending on the size of your business, relying on business equity to pay for retirement can seem like a no brainer or clinically insane.
While the degree to which business equity will help you retire will vary dramatically, even if you’re a freelancer and don’t have a lot of inventory or equipment does not mean you won’t be able to get some equity out of the business.
During my senior year of high school I knew I would be moving for school, so the question of what to do with the lawn service business I had came up.
Thankfully, I had an old friend from scouts who was starting a landscaping company himself. I had a book of business I needed to sell, and he needed a way to quickly acquire a decent amount of customers.
After some negotiating, I sold the book of business for about $3k and the equipment for another $1500.
$4,500 for a business that brought in $24,000 my last full year is not to shabby.
In my case I was saving for college not for retirement but the point remains.
No matter what industry you are in or what size of a business you have, something about it is valuable.
It could be the equipment, the customers, your expertise, a recipe, anything you can think of.
It might take some creativity to find a buyer or a way to get equity out of your small business, but don’t shortchange what you have created and just let it go to waste.
traditional and Roth IRa’s
On the opposite end of the spectrum, probably the easiest option to start saving for retirement is the traditional and Roth IRA.
Available at every major finance company, you can easily open up an account and choose from a wide variety of investments.
The only difference between a Roth and a Traditional IRA have to do with how they are taxed
– roth ira
Funds that you contribute into your roth IRA have already been taxed. They are post tax dollars. Because of that, when you decide to take the funds out of the account you pay no taxes on that money. You pay taxes when you put the funds in and then the principle and growth can be removed tax free once you turn 59 1/2.
– traditional IRA
In a traditional IRA, the funds that you put into the account have not been taxed. They are pre tax dollars. Funds in the account can then grow tax deferred and anything you take out of the account are taxed at your marginal tax rate for the year.
– which one?
Determining whether should invest in a traditional IRA or a Roth IRA really comes down to taxes and how you think your retirement will look.
If you think you will be in a higher tax bracket when you retire, you should always go with the Roth IRA. That way, you can pay the taxes now and then not have to pay them when you retire.
If you are in some of your highest earning years. You might want to do a Traditional IRA. That way you can get the tax benefit today and just have to pay them when you retire.
There is a lot more that can go into choosing which is better, and I’ll expand on that more in a future post.
One of the major downsides of both a traditional and roth IRA is that you have to have earned income in order to contribute. The maximum amount you can contribute if you are under the age of 50 is also capped at $6k. If you are over 50 they do allow an additional $1k “catch up contribution.”
There are also income limits and if you make over a certain amount you are not allowed to contribute to a Roth at all and the tax benefit of contributing to a traditional IRA may be lessened or removed.
While good options due to their ease of opening, a Roth or a traditional IRA will probably not allow you to save enough for retirement by their self.
Investopedia – Basics roth ira contribution rules
Investopedia – roth and traditional ira contribution limits
simple IRA
Slightly different than a traditional IRA simple IRA’s are set up by the business for the employees.
They come with the same tax treatment as a traditional IRA but have higher contribution limits. In 2022 an individual can contribute $14k. Simple IRA’s also have an additional catch up contributions of $3k if you are over 50.
While you can contribute up to 14k if you are under 5,0 the business has to contribute either a matching contribution of 1-3% or 2% of a non-elective contribution.
The non elective contribution just means it is not contingent on whether you individually contribute to the Simple IRA.
A business can decide every year whether they would like to do the matching contribution and what percentage or the non-elective contribution.
One important thing to note about simple IRA’s. For the employer contribution, every employee has to have the same percentage. If you have multiple employees and want to do the 2% non elective contribution, every employee that works at your company is mandated to receive it.
The major benefit of the Simple IRA is that they are quite easy to set up and most major financial services companies offer them.
https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan
sep IRA
Sep IRA’s are slightly different than the other options listed, as technically the employee can not contribute anything. Everything that gets contributed must be done by the employer. If you area sole proprietorship you would obviously be both of those people and be able to make contributions.
The contribution limit on a SEP-IRA is one of the highest of all of the possible options.
The employer contributions cannot exceed the lesser of:
- 25% of the employee’s compensation
- $61,000 for 2022 ($58,000 for 2021 and $57,000 for 2020)
If your compensation is 200k, the business could contribute 50k into your SEP IRA account.
This is way higher than a traditional IRA or a Simple IRA.
Similar to a simple IRA, whatever the employer decides to contribute has to be the same for all employees. If you are the only employee this is not really a factor. If you have multiple employees and decide to contribute a large percentage into your SEP IRA, it can get pricey doing the contributions for all of your employees as well.
Solo 401k / solo roth 401k
A solo 401k or solo Roth 401k are very similar to the traditional and roth IRA accounts just with different contribution limits.
The roth designation just means whether or not the funds are pre or post tax. It does not change anything else about how the solo 401k works.
You are only eligible for a solo 401k if you are the sole employee. The only exception being if your spouse works for the company as well.
Nerd Wallet explains the contribution amounts thoughly enough so I am just going to quote them
- As the employee, you can contribute up to $19,500 in 2021 and $20,500 in 2022, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,500 here.
- net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $290,000 in 2021 and $305,000 in 2022
One major benefit that the solo 401k has that all of the others IRA’s don’t is the ability to borrow money from the plan. While generally not an advisable thing to do, for businesses with uneven cash flows this can be helpful. The maximum amount you can borrow is the lesser of 50% of the value in the 401k or $50k.
brokerage account
The last way is to open a regular brokerage account. Instead of having contribution limits and tax implications when you add money or remove money, a taxable brokerage account is only taxed based on the transactions in the account. The contribution limit is unlimited and you only have to pay taxes on realized gains.
These rates range from 0-28% depending on your tax bracket.
The greatest advantage of a taxable brokerage account is the flexibility. All of the other accounts have some stipulations that makes it hard or costly to access the money should you need it before retirement.
https://www.irs.gov/taxtopics/tc409
so what?
Which option is best for you is going to depend on: your income, your business, how long you have to save for retirement, how much money you will be making when you retire, and many other factors.
At the end of the day any of these options are vastly better than not saving for retirement at all.
Personally, I think for most young people a Roth IRA is a great way to start.
I’ll leave you with an example :
- If you save $500 a month
- Starting at 25
- With an average return of 7%
You would have $1,312,406 to retire at the age of 65.
Using the 4% rule that would leave you with $52,000 a year for the rest of your life.
Until Next Time
GT