Being your own boss certainly has its perks. You can set your own hours and your own goals. But many freelancers and small business owners may feel that the tradeoff is not having access to a company pension plan like a 401(k).
The truth is, you have many options. So I’m going to walk you through these to help you choose one that’s right for you. Here’s what we’ll cover.
- Individual Retirement Account (IRA)
- Roth IRA
- Solo 401 (k)
- September IRA
- SIMPLE IR
You can easily open these accounts online with most financial institutions.
A traditional IRA offers many of the same benefits as a traditional 401(k). It’s funded with pre-tax dollars, so contributions can reduce your tax burden. But unlike 401(k) plans, you’re not limited to an investment menu set by the plan sponsor. With a traditional IRA and other plans we cover, you can invest in virtually any type of security, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and alternative assets.
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However, a key point about the plans we’ll be examining is that in most cases, if you fail before the 59.5. withdraw money for years. And unlike Roth IRAs, traditional IRAs require you to start making withdrawals at age 72. Because of the way traditional IRA tax benefits work, this option may be best for freelancers who expect to retire in a lower income tax bracket than they do now.
Traditional IRA tax benefits: Contributions to traditional IRAs are tax-deductible, so they can lower your tax bill for the year you contribute. Your income on the account grows tax-free. However, qualifying withdrawals are taxed at your normal income tax rate once you reach age 59.5.
contribution limits: $6,000 ($7,000 if you are 50 or older) in 2022.
With a Roth IRA, you cannot make tax-deductible contributions, but qualifying withdrawals are tax-free as long as you are at least 59.5 years old and have contributed for at least five years. Unlike a traditional IRA, you can withdraw your own contributions at any time with no penalty or tax. However, if you withdraw income without complying with the rules, you may owe a 10% penalty in addition to normal income tax on that income.
Also, not everyone can contribute to a Roth IRA. To make a full contribution to a Roth IRA in the 2022 tax year, your modified adjusted gross income (MAGI) must not exceed $144,000 if filing individually or $214,000 if filing jointly.
tax benefits: Contributions are made on an after-tax basis, your money grows tax-free within a Roth IRA, and qualifying withdrawals are tax-free.
contribution limits: $6,000 ($7,000 if you are 50 or older) for 2022.
Solo 401 (k)
A Solo 401(k) may be best for small business owners who have no employees other than a spouse. It offers many of the same perks as a traditional workplace 401(k), but its contribution limits are higher because you, as a business owner and as an employee, can contribute to yourself.
tax benefits: Contributions are tax deductible and capital gains grow tax-deductible. Qualifying withdrawals are taxed as ordinary income if you are at least 59.5 years old.
contribution limits: Because you contribute to a Solo 401(k) as both an employer and an employee, the contribution limits are somewhat complex. But here’s a breakdown.
- As an employee, in 2022 you can contribute, known as “election deferral,” up to $20,500 ($27,000 if you are 50 or older) or 100% of your earned income, whichever is less.
- As an employer, you can contribute up to 25% of net pay or choose not to defer, which requires some complex calculations to determine.
- Total contributions to an account may not exceed $61,000 for 2022 for those under the age of 50 or $67,500 for those over the age of 50.
The Solo 401(k) plan is officially referred to by the IRS as the One Subscriber 401(k) plan. It also works as follows.
- solo k
- A participant k
A SEP IRA may be best suited for small business owners with zero or few employees. This is because you must also contribute to an eligible employee’s SEP IRA plan. And for each employee, you must contribute a percentage of compensation equal to your own. So if you contribute 10% of your compensation to your own SEP IRA each year, you must contribute 10% of each employee’s compensation to their own account.
There is no SEP IRA Roth option that would allow for tax-free qualifying withdrawals. In addition, there is no catch-up contribution limit for people aged 50 and over. But the SEP IRA still has its advantages.
tax benefits: Contributions to a SEP IRA are tax deductible. Qualified withdrawals are taxed as ordinary income.
contribution limits: For 2022, SEP IRA contribution limits are the lesser of $61,000 or 25% of compensation.
The SIMPLE IRA was designed for business owners with 100 employees or fewer. Just like the SEP IRA, you must contribute to your employees’ SIMPLE IRA accounts. But you have two choices.
- Deposit at least 2% of each eligible employee’s compensation into their account, regardless of whether the employee contributes to the account.
- Make a 100% matching contribution up to the first 3% of commission.
tax benefits: Contributions to SIMPLE IRAs are tax deductible. Qualifying withdrawals would be taxed as ordinary income.
contribution limits: For 2022, you can donate up to $14,000 ($17,000 if you are 50 or older).
The final result
You don’t need a 401(k) to start saving for retirement. As a freelancer or entrepreneur, you have a handful of tax-advantaged accounts that you can open directly through a financial institution. But these are not one-size-fits-all solutions. For example, a small business owner with no employees may prefer a Solo 401(k) over a SIMPLE IRA. And those who can’t contribute much can be content with a traditional IRA or Roth IRA. Either way, it’s important to weigh your options and look for the best choice.
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