by Ken Adel
When it comes to saving for retirement, self-employed individuals sometimes face unique challenges compared to employees who work for a company that offers an employer-sponsored retirement plan. It’s fairly easy for employees to participate in a retirement plan at work — all they usually have to do is sign up for the plan, decide how much money they want to contribute and how they want to invest their funds.
Self-employed individuals, on the other hand, have to be more proactive when it comes to saving for retirement. This usually involves setting up their own retirement plan at a bank or brokerage firm or with an investment advisor and then funding the plan on their own — and obviously without the benefit of any kind of employer match.
Unfortunately, many self-employed individuals have not taken the initiative to set up and fund a retirement plan for themselves and their spouses. A survey conducted by the Freelancers Union found that 27 percent of freelancers have not saved any money at all for retirement.
The good news is that there are several types of tax-advantaged plans available to self-employed individuals to help them save for retirement. Three of the most popular of these plans are:
1. Individual Retirement Account (IRA) — There are two main types of IRAs: traditional IRAs and Roth IRAs. They provide the opportunity to potentially benefit from long-term, tax-deferred and tax-free, respectively, asset growth. With a traditional IRA, contributions are made on a pre-tax basis and taxes are paid at ordinary income tax rates when withdrawals are made during retirement. In addition, you may receive a current deduction in the amount of your annual contribution.
With a Roth IRA, contributions are made on an after-tax basis, so no taxes are due when the money is withdrawn in retirement. However, there is no current deduction for Roth IRA contributions, and eligibility to contribute to a Roth IRA phases out above certain income thresholds. The annual contribution limit in 2013 for a traditional or Roth IRA (or combination of both) is $5,500, or $6,500 if you’re age 50 or over.
2. Simplified Employee Pension IRA (or SEP IRA) — A SEP IRA is similar to a traditional IRA, but it features a higher annual contribution limit: up to 25 percent of net income or $51,000 in 2013, whichever is lower. Like with traditional IRAs, contributions to SEP IRAs may be tax-deductible.
You can contribute to both a traditional or Roth IRA and a SEP IRA if you choose. For example, if you want to take advantage of the after-tax status of a Roth IRA but also enjoy a current tax deduction, you could contribute $5,500 to a Roth IRA and additional money to a SEP IRA up to the annual contribution limit.
3. Solo 401(k) — This is similar to an employer-sponsored 401(k) but is designed for self-employed individuals. Contributions are made pre-tax and are deductible up to an annual limit of $17,500 in 2013, or $23,000 if you’re age 50 or over. Or, you can opt for a Roth solo 401(k) if you prefer to make after-tax contributions and pay no income tax when making withdrawals in retirement.
You can increase your annual solo 401(k) contribution significantly by giving yourself an “employer profit sharing contribution.” This boosts the annual contribution limit all the way up to $51,000 in 2013, or $56,500 if you’re age 50 or over. Note, however, that this is not available with a Roth solo 401(k).
Ken Adel is with David Lerner Associates and can be reached at (609) 806-2739. Material contained in this article is provided for information purposes only and is not intended to be used in connection with the evaluation of any investments offered by David Lerner Associates, Inc. This material does not constitute an offer or recommendation to buy or sell securities and should not be considered in connection with the purchase or sale of securities. Member FINRA & SIPC