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Self-Employed? Consider Self-Directed Retirement Plans

Self-employment is a beautiful thing. It offers a certain type of freedom, but it adds the stress of having to fund your own retirement unlike an employer providing a traditional 401(k) plan. Depending on your circumstances, certain self-directed plans may fit your business and retirement goals more: Traditional or Roth IRA, Solo 401(k), SEP IRA, or SIMPLE IRA.

Traditional or Roth IRA:
Known as the easiest way to save when self-employed for retirement, an IRA plan allows you to potentially rollover an old 401(k). For traditional IRAs tax deductions are permitted on whatever you contribute. No deductions on Roth IRAs, but you get to enjoy tax-free withdrawals in retirement.

2022 Contribution Limit: $6000 if under 50, $7000 if over 50. (Note: Roth IRAs have income limits so if you make too much you may be ineligible).

IRAs do not have designated employee elements. So, if you are hiring employees, they would have to open their own IRAs.

Solo 401(k):
This plan is best for the self-employed with no employees—and if applicable, a spouse could contribute. A solo 401(k) mirrors a traditional 401(k), but you are the employee and employer.

Let’s break that down. Pretend you are two people. As the employee you can contribute like you would with a standard employer sponsored 401(k) plan. In 2022 that would be whichever is less: up to $20,500 or 100% of your salary deferrals (plus a $6000 catchup if eligible). As the employer, you can make additional contributions, maxing at 25% of income.

Since the plan works like a standard 401(k), you make the contributions are tax-deferred, meaning you are taxed upon withdrawal.

Notes: This plan is great for saving loads of money for retirement. However, these contributions are per person, not per your plan. If you have other employment that offers a 401(k) (or your spouse does if contributing to the solo 401(k)) these contribution limits cover both 401(k) plans.

Having simpler maintenance than a solo 401(k), SEP IRAs are flexible so that you do not have to contribute annually. Self-employed people or business owners with only a few employees benefit the most from this plan. Although no catchup contribution, SEP IRAs have the same contribution limits are solo 401(k)s: lesser of $61,000 or 25% of compensation (though limited at $305,000 in 2022).

Luckily, you can deduct the lesser of your contribution, restricted at the cap of $305,000. Withdrawals are taxed as income in retirement.

If you have employees, you must contribute the same to theirs as you did to yours. So if you did 15% for yourself, you must match and contribute 15% to each eligible employee. (Note: you are counted as an employee, that is why).

Note: There is no Roth SEP IRA.

As the top choice for mid to large businesses up to 100 employees, SIMPLE IRAs are easy to setup and the employees own their own accounts. However, contribution limits are less than SEP IRAs and solo 401(k)s. Employees can contribute up to $14,000 (and a catchup amount of $3000 if over 50) in 2022. If as the employer you are contributing, too, the max contribution limit is $20,500.

Although these accounts are not as flexible, contributions are deductible and tax-deferred to withdrawal in retirement. Whatever contributions are made by the business is tax deductible as a business expense. Note: A 401(k) SIMPLE is also an option. However, these are more expensive to setup and require much more oversight.

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