If you are self-employed, while you may not have an employer matching a percentage of your contributions, you can still structure your retirement in an intelligent way so that you don’t have to pay higher income taxes than necessary.
The Solo 401(k) Plan / Solo Roth 401(k) Plan
The Solo 401(k) plan is designed specifically for self-employed individuals with no employees. Only you alone can use the Solo 401(k), hence the name. The way it works is much the same as a regular 401(k) plan. You put money into the account without it being taxed, the earnings on which gives whatever fund you have invested in even more money to reinvest. Upon retirement age, you withdraw the money and get taxed then, presumably when your income is lower and the deferred taxes are not as great as they would have been before your retirement.
The Solo Roth 401(k) plan works like a Solo 401(k) plan, except that the money is taxed when you put the money in rather than when you withdraw it. You also aren’t taxed on a yearly basis on your investment earnings. The reason you want to do this is primarily because you believe you will be in a higher tax bracket when you withdraw your money. If you believe that your tax bracket will be much higher in the future, it may make more sense to pay taxes now rather than later.
The SEP IRA Option
The SEP IRA is another great choice for self-employed individuals because of its ease of use and flexibility. It has no annual minimum contribution, meaning that even if you put in $30,000 last year, this year you are not obligated to invest any money. This is especially important in the running of a small business. The SEP IRA gives you the flexibility to invest as much or as little as you want, with a ceiling of $49,000 a year or 20 percent of your income. Finally, SEP IRAs tend to be easy to get into with few legal or bureaucratic issues.
A Few Tips on Saving for Retirement
Make sure you talk with at least four different advisors before you decide who should handle your investments. When you are talking with advisors, make sure you look at their historical returns over at least the past ten years. Calculate how much money you believe you will need upon retirement, and make sure to factor in social security income and a rise in the cost of living as well. Once you have this number, it becomes much easier to calculate how much you need to save for retirement.
Diversify your investments among small cap, mid cap and large cap stocks, as well as bonds. Also be sure to invest in either foreign companies or companies that have a large percentage of income from foreign sources.
If you invest only in U.S. companies, you are effectively placing a wager on the U.S. economy, which may or may not pan out when it is time to retire, as we have seen with the recent recession.
We’ve just covered a couple of the most effective retirement vehicles, along with a few tips for planning for retirement. Explore your investment vehicles with an advisor, talk to several people before making a decision, and diversify your investments. Even as a self-employed person, you can plan for a very nice retirement package.
