The average Social Security check won’t even cover the current price of a one-bedroom apartment in most U.S. cities — never mind the cost it will be in a few decades!
What’s your backup plan? Do you have one?
25 percent of Americans don’t have any retirement savings. Even for those who do, many aren’t on track to have any significant amount saved when they retire.
Solopreneurs are more likely than average to have no retirement plans. After all, you don’t have a company taking care of it for you.
However, you’re still aging, and those golden years will get here eventually.
It’s vital that you take charge of preparing for your retirement.
Let’s explore three retirement options that will not only help you plan for retirement, they can actually save you money now.
You’re Your Own Employer
One of the biggest perks of being an employee is not having to worry about benefits. That’s the employer’s job. But when you go solo, you’re the employer. So that’s on you.
Employer benefits typically include things like health insurance, life insurance, and dental and vision plans. Flexible spending accounts or health savings accounts, social security taxes, and retirement benefits like 401k’s are just a few of the benefits employees have come to expect.
As a solopreneur, you need to decide what benefits you want. And you’re responsible for setting up each of them.
Oceans of ink could be spilled describing which benefits you need most and how to choose them. This article is going to focus solely on retirement planning.
Social Security Is Not Retirement Planning
When you’re an employee, retirement planning is fairly easy. You fill out some paperwork when you’re hired, and the company handles it from there.
They invest whatever percentage of your salary you agree to, and may even match it with company funds. They also pay half of your Social Security taxes.
As a solopreneur, you pay the whole 15.3%. But don’t make the mistake of thinking these self-employment taxes count as retirement planning.
The average Social Security check is only $1,555. You’re not exactly going to retire to Fiji on that income.
Could you live on that amount now? How about when you retire? If not, then you need to start planning for your future.
Full disclosure: Solopreneur Life and I are not Certified Financial Planners and are not giving you specific personal or financial advice. Please consult your financial advisor before deciding on any specific investments.
Starting Your Retirement Plan
There are basically three steps you need to take as you start your retirement planning.
- Make sure you have an emergency fund.
Many people have a rainy day fund. This is a savings account set up to cover emergencies that might arise, such as a car breakdown or an unexpected home repair.
Most experts recommend having at least $1,000 in this account.
But an emergency fund is different from a rainy day fund — an emergency fund will help you ride out more serious disasters such as a job loss.
Most financial planners recommend saving 3-6 months of household expenses for an emergency fund. This is even more important if you’re running your own business.
Remember, this money should be considered separate from any other savings you may have, such as a house fund or vacation fund.
- Choose a retirement account.
After your emergency account is funded, you need to start a retirement account. We’ll go into more detail in a bit, but you have three options to choose among.
- Decide how you want your money invested.
Finally, you’ll need to decide how the money gets invested. Most brokerage houses have guides or preset allocation plans that will help you. Some have automatic investing options based on your goals.
The most important thing to remember is to do it. Open an account and start saving.
Three Easy Retirement Plan Options for Solopreneurs
Let’s focus now on the types of retirement plans available to solopreneurs.
There was a time not too long ago when your only choices were a Traditional or Roth IRA.
While you can still pick either one of those — and they are great options — you can also set up a Solo 401(k) or a SEP IRA account.
Which one is right for you? That depends on your income and your goals.
Option 1: Traditional or Roth IRA Account
This is the simplest form of retirement planning account and is the easiest to open. You can do it in just a few minutes on any brokerage website.
What’s the difference between the two?
- A Traditional IRA is pre-tax dollars. (That means you can deduct the amount you invest from your income each year.)
- Roth IRA is after-tax dollars.
If you select a Traditional IRA account, you have until April 15 to make contributions for the prior year. That means you can wait until you see how big your tax bill is going to be and put part of that money towards your retirement instead of giving it to Uncle Sam.
This applies to all tax-deductible retirement accounts and is an especially good way for high-income earners to reduce their tax liability.
Pros: Easy to open. It’s no more difficult than a bank account. You can choose a tax deduction now with a Traditional IRA. Or choose a Roth and pay taxes on your contributions now. With a Roth, you won’t pay taxes on the withdrawals you make in retirement.
Cons: There are limits to how much you can invest each year. The limit is $6,000 if you’re under 50 and $7,000 if you’re over 50.
Option 2: Solo 401(k) Account
This is just like a traditional 401(k), except that you count as both employer and employee.
This means you can contribute more. As with IRAs, you can choose a traditional 401(k), which means your investments are pre-tax to lower your taxable income each year, or select a Roth 401(k), which invests after-tax dollars.
Everyone can set up an IRA whether or not they are self-employed, but the solo 401(k) was designed not just for the self-employed, but for the solopreneur. Be aware, you can’t have one if you have full-time employees. (Your spouse doesn’t count.)
Pros: The maximum you can invest per year (the contribution limit) is $58,000 in 2021. Up to $19,500 can come from your role as “employee” and thus come right off the top of your taxable income.
Cons: You must fill out some paperwork to start one. Also, once the total in the account exceeds $250,000, the IRS wants you to file a form with your taxes every year.
Option 3: SEP IRA Account
Overview: This is a special type of IRA with a higher contribution limit. Some business owners create them because they can add their employees to the plan. But you don’t have to have employees, making it ideal for solopreneurs.
This is the best option for solopreneurs with high incomes or those who expect to have a high income in the years ahead. It has the highest contribution limit and is a traditional IRA.
SEP stands for Simplified Employee Pension. All that means is it’s similar to a pension plan from a traditional employer.
Pros: You can contribute up to $61,000 per year, or 25% of net income, whichever is less. All investments are pretax, so they come straight out of your taxable income. There’s no paperwork to file every year and they’re easy to open.
Cons: There’s no Roth version and all distributions will be taxable.
So How do I Get Started?
Any of the options described above are great choices for most solopreneurs. The most important thing is that you open an account and start contributing to it.
Your accountant or financial planner can help you pick the best option for you. Call and ask to make an appointment to discuss your retirement planning. Make a list of any questions or concerns you have and take them to the appointment. Here are a few questions to get you started:
- How much money do I need to retire?
- When will I be able to retire?
- How much do I need to save per year to retire by [preferred] age?
- What’s the best way to invest my retirement savings?
You don’t want to wake up one day to discover you’re unable to work and have nothing saved. You’re not going to get any younger, and when you get older, you’ll be grateful you had the foresight to plan ahead.