How Do I Save For Retirement When I'm Self Employed?

How do I save for retirement when I'm Self Employed? What are the options for retirement plans?

Join us this week as we discuss small business retirement plans. We will explain the different options available and how to make the best choice based on your business's and personal needs.

Option 1) SEP (Simplified Employee Pension): A simple, employer-funded IRA plan where employees can't contribute, but the employer makes contributions based on a percentage of employees' wages. It’s easy to set up and less expensive but has lower contribution limits.

Option 2) SIMPLE IRA (Savings Incentive Match Plan for Employees): A plan similar to a 401(k), but with lower costs and simpler administration. Employees can contribute, and employers are required to match at least 3% of employee contributions. This plan is best for smaller businesses with fewer employees.

Option 3) Traditional 401(k): A more complex and expensive plan but allows higher contribution limits and more investment options. It’s more suitable for businesses with more employees but requires more administration.

Option 4) Solo 401(k): A plan designed for business owners without employees. It allows both employer and employee contributions, offering higher contribution limits than a SEP or SIMPLE IRA, with fewer administrative requirements until the business reaches $250,000 in assets.

It is important to select the right plan depending on the size of the business, the number of employees, and tax-saving goals. There is a solo 401(k) calculator (link below) that can help you determine which plan may be right for you. Additionally, you can always consult with financial planners or CPAs to optimize your retirement savings strategies!

Resources:

- Link to Solo 401(k) Calculator: https://www.solo401k.com/calculator/

- Alliance of Comprehensive Planners: https://www.acplanners.org

- John's firm website: https://www.trinfin.com

-Find us on Facebook: www.facebook.com/friendstalkfinancialplanning

#ACPMemberWisdom #selfemployed #retirement #retirementsavings #retirementplanning 

TRANSCRIPT:

John: If you run a small business, it's really easy to pick a retirement plan, but it's not simple. And on this episode of Friends Talk Financial Planning, we're going to dig into the options that there are out there and how you can make the best decision for you. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. And before we continue talking about small business retirement plans, please hit subscribe. It helps other people find us. All right, John, let's dig into these simple but not easy retirement plans. I think this is important because it helps people save a whole bunch of money.

John: Yeah, that's right. And when you run a business, you have opportunities that are available to you that you don't when you're just a regular W-2 employee. So it's opportunities, but it's also more to think about, more responsibility.

Bridget: And a little more complicated.

John: Yeah. So let's maybe just start by reviewing the three major types of retirement plans. And I'll go back to sort of the old days, but they are still available here today. But there's one called a Simplified Employee Pension, or a SEP.

Bridget: Right.

John: And that's an IRA based retirement plan. And it basically works that literally every employee has an IRA, and the company puts money in. A percentage of the employees’ wages go into the IRA every year, then the employee does what they want to do with it. It's simplified or it's simple. Everybody's got a super IRA contribution. Employees can't put any money into it. It's just an all employer contract, all employer deal. Those were really popular. I used to recommend those all the time back in the 90s and early 2000s.

Bridget: Right. Yeah, it's simple, and it's easy to set up the accounts.

John: Right.

Bridget: And CPAs recommend these all the time. And I think one reason might be because it's easy to get on people's tax returns too, which doesn't seem like a big deal (what kind of benefit is that?) but actually getting it reported correctly is a bigger plus to it than you would think.

John: Yeah. I forget about that. All this stuff sounds good, but when the rubber meets the road, how complicated is it?

Bridget: Right, exactly. So that's the SEP.

John: Yeah. And then the second level. About 20 years ago or so these SIMPLE retirement plans came and that's an acronym for something, but SIMPLE is sort of like a watered-down version of a 401(k) plan, which many people are sort of familiar with how that. Effectively, the rules are employees can defer money into this plan and then the company effectively has to make a 3% match to the plan. There're some other rules, but this is not the forum to get into all the details. If you think of it generically, hey, employees can defer what they want to.

Companies aren’t going to put in 20% or 10% of somebody's salary, but they have to put in 3% and match what they put into it. And so, what's changed between those two is the company contribution is much smaller generally. It's required. Whereas with a SEP, you can decide how much you want each year, but it's a much lower contribution and it puts more power in the employees’ hands as far as how much they want to contribute, sort of like how much they want to contribute to a 401(k). I can defer money into that plan.

Bridget: Yeah. It's up to the employees to contribute. So if they don't contribute, then they don't get the match and that doesn't cost the employer much.

John: That's right.

Bridget: That's another reason why these appeal to some people.

John: Right. And it is simple. The low overhead. There's very little in the way of reporting. And the contribution limit for the SIMPLE plans for the employees is you can put in up to $16,000 of your income.

Bridget: Yeah. So it's not bad.

John: Right. And then the maximum contribution is $21,000 between employee and employer. So that's not a bad deal. The problem with regular 401(k) plans (we'll move on to that level next) is that though it’s a great place that a lot of people are familiar with, it comes with a lot of regulations. There's reporting, and there're expenses that go with that.

Bridget: And it's more expensive.

John: Yeah. And when I say small business, there's a lot of different definitions, but in my mind, Bridget, I'm thinking about some client-based work and friends who say, “Hey, it's just me,” or “I got one part time person that works for me.” That’s that sort of small business where, geez, I'm not going to pay a couple thousand bucks a year to have a 401(k) administered for that. It just doesn't make sense. But a SIMPLE plan where I can put them up to $16,000 away, and I don't have to match a gigantic amount for my employee, but I can let him or her defer more into it. There're some really cool places for that.

Bridget: And I personally had a SIMPLE plan when I had my tax practice. So I've actually experienced with it. It worked fine. Mine was actually through Vanguard. I don't know if they're still in the business of doing SIMPLE plans. Not all custodians are going to offer SIMPLE plans. They're not as ubiquitous as SAPs are. You're going to get fined pretty much everywhere. So you might have to poke around a little bit to find your SIMPLE plan.

But I had it, and it worked great. It was perfect for what I needed it for, which was a non-expensive retirement plan that my employee (I had one employee at the time) could use, and it was up to them whether or not they wanted to contribute. And I wanted to start saving, so I was saving. It worked out great.

John: Perfect setup. That's great. The other place that I want to make sure we talk about here is the regular 401(k). It's great, but it's expensive.

Bridget: I’ve got one of those now; you probably have one too.

John: Yeah. And I mean it fits. But for some people who think, listen, I just want it to be simpler and lower key, there's a thing that's called a solo 401(k) or individual 401(k). To qualify for this now you can't have employees. So if we take employees out of the picture now, a solo 401(k) might make some sense. Until your dollar amounts get pretty big, there's no IRS filing. It's really simple until it gets up to a certain amount. I think the number is $250,000, then there's some reporting things. But even at that, it's not the complicated thing that a regular 401(k) is.

Bridget: Yeah.

John: But what works for that solo 401(k) is now I can do an employee deferral, just like I can from a SIMPLE or a regular 401(k), but the 401(k) limits are higher. I can put in over $23,000 this year as an employee. And if I'm above 50, I can do the catch-up thing, too, so maybe upwards of $30,000. And I can make an employer contribution like in a SEP, where it's 25% of my income or 20% of profits.

There're some calculations that go into it, but, listen, I can do an employer contribution basically the same as a SEP and I can do an employee contribution on top of that all so I can double dip on those things. It's not the either-or sort of thing you get with a SEP or a SIMPLE. And it works for a single person, and if it's a husband and wife that are working in a business, that counts as a solo 401(k), too. So you can still do that if there's a couple that work in a business. Employees muddy the water, so it doesn't fit there.

Bridget: Yeah. As soon as you get employees, the party ends.

John: Right.

Bridget: But then you switch it over to a regular 401(k), so I've had this one too.

John: Yeah, exactly.

Bridget: It's really one of my favorites because you can put in a lot, it's inexpensive, and you've got a 401(k) where you can invest in whatever you want.

John: Right.

Bridget: That's another benefit. I think a lot of people probably don't care, but 401(k)s have to have specific investment options like this fund, that fund, the other fund. Whereas these solo 401(k)s, you can put it in whatever you want, within some reason, I don't want to say everything but so they're an awesome option. I love that. Yeah, I guess I've tried them all, except for just a plain set.

John: Let me give an example. I got a buddy who is not a client of mine at all, but we're sitting talking one day and he says, “Oh yeah, my CPA says I need to set up a SEP here. Can you help me do that?” I said, “Oh, I'll walk you through it, but these days SEPs aren’t very common.” And his wife makes a good living. I know that they live off of her income, and he's doing this consulting gig, so he’s got some extra money coming in. And I said, “Boy, it's interesting because, a SEP 25 years ago was a great deal. But with the solo 401(k), with a SIMPLE, it's almost never the right answer.”

So I said, “Well, tell me a little bit about this. What's going on. What are your profits this year?” He said, “Geez, I'm going make like $80,000, and then I want to shelter some taxes, because we're in a high tax bracket. But when we retire, we're going to be in a lower bracket, so I want to sock away some money.” We use a thing and we'll put a link in the show notes, but it’s a solo 401(k) calculator, and it says, “Hey, tell us what your business looks like, what your profits are, and we'll lay out what it looks like for a solo 401(k), what it looks like for a SEP, what it looks like for a SIMPLE.”

And so, his CPA was saying, “Hey, we should do a SEP.” And when he has $80,000, he can put away 25% of that. So we can put $20,000 into a SEP. All right, that's good. Well, we ran those same numbers, we plugged things into the calculator, and based on that income, with a solo 401(k), he could do $20,000 as an employer contribution. He happened to be over 50, so he could also do $31,000 as an employee contribution, and save taxes on that extra $30,000. So instead of his tax deduction being $20,000 his tax deduction was $51,000.

And in their tax bracket, take an extra $30,000 of deductions, that's a $5,000 to $10,000 tax savings, literally cash in pocket. And he actually talked to the CPA and said, “My buddy says this. Does it make sense?” And the CPA said, “Well, geez, yeah, if you had enough money, you could do that.” And he was telling me, “I got this money. I don't know what to do with it. Could I invest it someplace else?” Sure. But if I put it in my 401(k), I save $8,000 in taxes. That was a really good deal. But the CPAs typically aren't wired to think about that stuff.

But it's really important to know that this is an option. If you're not looking to save money, and you're spending all that money. Big deal. But if you're looking to save, hey, I got some extra cash, I want to save this, this is great. My buddy is a perfect example of somebody who wouldn't have been well served with a SEP. And by doing the solo 401(k), he got exactly what he needed. It’s just a slam dunk for people in that situation.

Bridget: Yeah. And I think what happens is that in your early life when you're setting your spending habits, a lot of times people aren't really saving super aggressively. They're just doing what they need to. But then as they get older, they might be in a wonderful place where they can save more. And so, it might not be a core principle of their being, but they're thinking, “Oh, wait, I can save more now. How am I going to do that?” And that's especially when being able to really sock a lot away in retirement plans makes a lot of sense.

John: Yeah, that's great. Hey, that's a great place to wrap things up here. Again, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. John and I are both proud of the Alliance of Comprehensive Planners. If you like what you hear from us, we're both taking clients. But if you want to find someone in your area, you can check out acplanners.org.

John: And don't forget to hit that subscribe button.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.