Simple retirement savings options for your small business

Hand putting change into a jar for savings

By: Whitney Hodge

Published: December 21, 2021

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Taking the leap into becoming self-employed is one that most people will be quite envious of. It’s this beautiful dream of being able to manage your own schedule, work when and from wherever you want, and really take control of your future. 

But there is one little thing that a lot of us forget, and that is what are we going to do when it comes to retirement?

We’re going to explain the options that you have to choose from and guide you through the process so you can sleep easy knowing that your future is taken care of.

Don’t lose out on your retirement

By far the best part of not being self-employed is that things like your pension are just taken care of. They’re automatic! You don’t even see the money or barely even think about it. Those bills just go flying off to a cozy place and you won’t see it again until you reach the ripe age of 67.

In the US now, a whopping 37% of the total workforce is self-employed! 

So what do you do if you are self-employed? 

Well, the one perk that you do have is that there are many options available. 

What are my options?

Depending on the size of your business and the amount of money you want/plan to put aside for your retirement, there is an option that is best suited to you. We want to make this as easy-to-understand as possible without missing out any important details.

Traditional or Roth IRA

If you are just starting your own business or moving from full-time employment into self-employment, these two options will be the best for you.

A Roth IRA is different from most retirement plans where you contribute pretax income that gets taxed when you withdraw the money upon retirement. Instead, your contributions are made post-tax, and they can be withdrawn at any time, tax-free. If you are under 59½ years of age and have had the account for less than five years, you will usually be required to pay taxes on your withdrawal. Once you have reached this age, withdrawals are tax-free.

This may seem like a great deal, but it does come with some restrictions. For 2021 and 2022, the maximum contribution you can make to a Roth IRA is limited to $6,000, or $7k if you are over 50. 

The other restriction is based on your salary. You cannot contribute to a Roth IRA if you have a modified gross income (AGI) of $208k or more if you are married, and $140k or more if you are single. 

If you have a modified AGI of between £198k and $208k, or between $125k and $140k (for married and single respectively), your maximum contribution will be reduced.

With a Roth IRA, you have no obligation to withdraw money, making it an ideal solution if you intend to pass it on to an heir.

Contributions made to a Traditional IRA are generally tax-deductible unless you (or your spouse) have access to a workplace retirement plan. This also applies if your income is between $65k and $75k (single) and $104 and $124k (married), taking into account your AGI and modified AGI. 

Taxes are paid when you withdraw the money which you can start doing at age 59½ (sometimes earlier) and you must start withdrawing money at age 72. 

SEP-IRA

A Self Employed Pension (SEP)-IRA is the best option for self-employed individuals or small businesses with no or very few employees. 

For 2021, you will be able to contribute up to 25% of your net earnings from self-employment, or $58k (increasing to $61k in 2022), whichever is the lower figure. In 2021 there will be a limit for compensation of $290k, increasing to $305k in 2022. This compensation is used to factor in the contribution, for which you will need to make some calculations

SEP-IRAs have higher contribution limits than most other retirement plans meaning you can save faster, and the contributions are tax deductible. The only downside is that you are not allowed to make catch-up contributions—that means that even if you are 50 or over, you cannot make additional contributions as it will exceed the limit.  

A SEP-IRA is easier to maintain than a solo 401(k) to maintain with far less paperwork required and no annual reporting to the IRS, while enjoying the benefits of high contribution limits. They are also flexible, so you are not required to contribute every year. 

The flipside is that you, the business owner, will need to make contributions for employees. You cannot just use an SEP to save for yourself. The percentage of pay for your employees needs to be equal to what you make for yourself. This has potential to be costly the more employees you have, or if you plan on a very large retirement package. 

One-person 401(k) plan

This plan is perfect if you are a business owner or self-employed individual with no employees, with the exception of a spouse (if applicable). 

It functions in a similar manner to a workplace 401(k) in that you make pretax contributions and are taxed when you begin to make withdrawals, which you can start doing at age 59½. You can contribute twice, once as an employee of your business and a second time as an employer. 

As an employee, you can contribute up to 100% of your annual salary into the plan. The limit is capped at $19,500 for 2021, increasing to $20,500 in 2022. If you are aged 50 or above, you can make an additional catch-up contribution of $6,500

As the employer, you can make a contribution of up to 25% of your maximum contribution limit, which you can calculate using an IRS worksheet. 

The maximum employer contribution in 2021 is $58k, excluding catch-up contributions, and this will be increasing to $61k for 2022. 

A one-person 401(k) plan is a very attractive option for those who intend on saving a significant amount of money for retirement, or those looking to save a lot of money in a few years when business is booming. 

SIMPLE IRA

A Savings Incentive Match Plan for Employees—aka a SIMPLE IRA—is designed for mid-sized businesses with up to 100 employees. 

If you have received a minimum compensation of $5,000 from your business in the last two years, you are able to make pretax contributions to a SIMPLE IRA. 

In 2021, you can add in up to $13,500 of your net earnings ($14k in 2022) and an additional $3,000 if you are aged 50 or over. 

You can also contribute up to a 3% match of your net earnings from self-employment, or choose to make a fixed contribution of 2% of self-employment net earnings as long as it does not exceed $290k in 2021 or $305k in 2022.

There are a couple of things to note. While the contribution limits are lower compared to a SEP IRA or solo 401(k), you may be required to make contributions to employee accounts which can get expensive with a larger workforce. 

SIMPLE IRAs are also inflexible. This means that if you make withdrawals before you reach age 59½, they are taxed as income and subject to a 10% penalty which increases if the withdrawal is made within the first two years. The consequence? You cannot roll a SIMPLE into another retirement within the first two years.

How much do I need to save?

This is a bit of a moot point because it is dependent on a large number of factors, particularly what kind of a retirement you want. It is important to remember that, in general, your expenses do decline in retirement. 

The recommended figures also vary between private and public resources, with suggestions for your retirement to replace between 45 and 90% of your pre-retirement income. 

We can break it down into one of the more recognized sets of figures from investment giants Fidelity which suggests a figure to aim for each decade. 

At age 30, you should have one times your annual salary saved. Then two times at 40, four times at 50, six times at 60, and eight times at the retirement age of 67.

One of the most important things to remember is that it isn’t too late, and if you have fallen behind on your plan don’t worry because you can always catch up. 

Secure your future

Building a retirement strategy is hugely important if you are a freelancer because you are solely responsible for it.

While a lot of people will think that retirement money is something that you should put away when you have a bit left each month, this is an unproductive and borderline risky way of looking at it. 

Instead, plan to put away an amount each month before other expenses. Pay yourself first! 

Trust us, you will definitely enjoy the benefits down the line. And if you are looking for any advice, at Lloyd & Hodge we have overseen hundreds of succession transfers and we are happy to help you make the best decisions to make to secure your future. 

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