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5 Steps to Create Your Own Self-Employed Benefits Package

Think you have to sacrifice benefits when you leave a traditional job? Laura explains how to create your own benefits package when you're self-employed and answers several related questions from Money Girl readers and podcast listeners. 

By
Laura Adams, MBA,
Episode #533
QDT Newsletters

5. Contribute to a Tax-advantaged Retirement Account

Another essential benefit you’ll need to handle on your own after becoming self-employed is contributing to a retirement account. There are great options to invest for the future, even when you don’t have a traditional day job with a 401k.

There are great options to invest for the future, even when you don’t have a traditional day job with a 401k.

Question: A member of Dominate Your Dollars, my private Facebook group, named Kate Haas asks, “I have multiple part-time jobs as a self-employed independent contractor. What are my best options for retirement?”

Answer: Here’s a summary of four different types of tax-advantaged retirement accounts to consider when you work for yourself.

1. Traditional IRA (Individual Retirement Arrangement). For anyone with earned income under the age of 70½. Even non-working spouses who file taxes jointly with a working spouse qualify for a spousal IRA.

Contributions are tax-deductible, which means they reduce the amount of income on which you pay tax. The only downside is that if you or a spouse also participate in a workplace retirement plan (like a 401k or 403b) some or all your contributions to a traditional IRA may not be tax deductible. Another negative is that IRAs have low annual contribution limits compared to other retirement options for the self-employed. For 2018, you can contribute up to $5,500, or $6,500 if you’re age 50 or older.

Additionally, if you take money out of a traditional IRA before age 59½, you’re subject to income tax plus an additional 10% early withdrawal penalty.

See also: 10 IRA Facts Everyone Should Know

2. Roth IRA. For anyone with earned income up to certain limits, no matter your age. 

Contributions are taxed up front, but withdrawals during retirement are completely tax free. That allows you to avoid paying tax on decades of earnings and growth in a Roth.

You get the full tax benefit even if you or a spouse participate in a retirement plan at work. Additionally, you have more flexibility to withdraw Roth IRA contributions (but not the earnings portion) before retirement without triggering tax or penalties if you’re younger than age 59½.

For 2018, you can contribute up to $5,500, or $6,500 if you’re age 50 or older. That’s the total limit for all IRAs. For example, you could contribute $2,000 to a traditional IRA and $3,500 to a Roth IRA in the same year, but not $5,500 to both types of IRAs.

3. SEP-IRA. A traditional IRA for anyone who is self-employed without or with employees, no matter if you’re set up as a sole proprietor, partnership, or a corporation. It stands for Simplified Employee Pension and is one of my favorite plans because it’s easy and inexpensive to administer.

For 2018, you can make SEP-IRA contributions for each of your employees (including yourself) up to 25% of compensation for a maximum of $55,000.

With a SEP-IRA, contributions can only come from an employer—your employees can never contribute their own money. So, as the business owner, you choose the amount to contribute each year.

For example, let’s say you have a small web design business with one employee named Jose. If you choose to have the company contribute 10% of your income to your own SEP-IRA, you’d also have to contribute 10% of Jose’s pay to his SEP-IRA.

For 2018, you can make SEP-IRA contributions for each of your employees (including yourself) up to 25% of compensation for a maximum of $55,000. You can also max out other accounts, including a traditional or Roth IRA and a retirement plan with another employer, such as a 401k or 403b.

But if you have a bad year with little profit, you can choose not to make any contributions to your SEP-IRA. Employees are always vested in their account, which means if Jose leaves your employment, he can take his retirement money with him.

Just like with a traditional IRA, if you or your employees take money out of a SEP-IRA before age 59½, you’re subject to income tax plus an additional 10% early withdrawal penalty.

See also: 401k or IRA--Which One Should You Invest in First?

4. Solo 401k. A traditional 401k or Roth 401k for anyone who is self-employed with no employees, other than a spouse. As both the employer and employee in your business, you can make both kinds of contributions to a one-participant 401k account.

This arrangement allows to you contribute more with a solo 401k than any other type of retirement account. Unlike a Roth IRA that imposes income limits, you can contribute to a Roth solo 401k no matter how much you earn.

For 2018, on the employee side of a solo 401k, you can contribute as much as 100% of your salary up to $18,500 or up to $24,500 if you’re 50 or older. Plus, as the employer, you can contribute up to 25% of compensation, if your total contributions don’t exceed $55,000, or $61,000 if you’re age 50 or older.

Be aware that if your business is a side gig, such as doing freelance writing or weekend photography, and you also participate in a 401k as an employee at another company, the total employee contribution you can make to both plans is $18,500 or $24,500 if you’re age 50 or older.

You can also have a solo 401k in addition to a traditional IRA or a Roth IRA. However, depending on your income and tax filing status some or all your contributions to a traditional IRA may not be tax deductible. 

If you need help setting up a retirement plan or aren’t sure how to use multiple retirement plans properly, be sure to contact a qualified tax accountant. Paying a professional to help you maximize tax benefits for your business and retirement accounts will pay off.

The bottom line is that you don’t need to work in a traditional job to enjoy a great benefits package. In fact, when you create your own, you can customize it any way you like.

Do your homework, shop around, and factor the costs of self-employed benefits into your business. Don’t let benefits be a stumbling block to creating your own venture and living your dream of becoming an entrepreneur.

See also: Can You Contribute to Both a 401k and an IRA in the Same Year?

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