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What the Self-Employed Should Do When Planning for Retirement

Although the self-employed generally enjoy more flexible hours and can work from home, they’re disadvantaged by a lack of benefits and available retirement options. Therefore, to prepare for their futures, the self-employed must strategically plan for their retirements by creating effective savings plans and investing in solo 401(K)s, IRAs, and other individual retirement accounts.

Failing to plan ahead can spell doom for the self-employed as they age out of the workforce. To avoid poverty in their older age, they must start planning now. In the article below, methods for how the self-employed can prepare for retirement, as well as available options that will provide a strong footing for a comfortable old age are discussed.

Retirement Planning is All About Timing

Regardless of how a self-employed worker plans to save for their future, the most important point for them to remember is that there’s no time like the present. The sooner a person begins saving, the more time their money has to grow. Even a small amount of money saved each month can add up over time, especially if it’s invested.

For example, if a 25-year-old self-employed worker saves $200 per month and earns a 7% annual return on their investment, they’ll have saved more than half-a-million dollars by the time they retire at 67. If the same worker waited another ten years to start saving, they’d only have about $250,000 by the time they retired.

Due to the compounding nature of an investment, the more time a sum of money has to grow, the faster it will double after a certain number of years. So, the takeaway is that time is of the essence when saving for retirement, and the self-employed can’t afford to procrastinate.

Traditional IRAs vs Roth IRAs

When it comes to saving for retirement, the self-employed have a handful of options. The most common retirement savings accounts are traditional Individual Retirement Accounts (IRAs) and Roth IRAs.

A traditional IRA allows the account holder to make tax-deductible contributions, which lowers their taxable income for the year. Any contributions made to the account grow annually without tax until the account holder reaches retirement age and drawing taking distributions. At that point, the account holder will owe taxes on their deductions.

A Roth IRA is the opposite. Contributions are made with after-tax dollars, so there’s no immediate tax break. However, all contributions made to the account grow tax-free and can be withdrawn as soon as an employee reaches 59 ½ years old.

For the self-employed, a Roth IRA may be the better option. This is because the money in a traditional IRA is taxed as ordinary income when it’s withdrawn in retirement, and the self-employed are already in a high tax bracket. With a Roth IRA, the money is taxed at the current tax rate, which is likely to be lower in retirement.

Solo 401(K)s

In addition to traditional and Roth IRAs, the self-employed can also consider a solo 401(K). A solo 401(k) is a retirement savings plan for self-employed individuals and their spouses. Like a traditional 401(k), a solo 401(k) allows the account holder to make tax-deductible contributions and enjoy tax-deferred growth on their investment.

The biggest advantage of a solo 401(K) is the high contribution limit. In 2020, the contribution limit was set to $19,500 for workers under the age of 50 and $26,000 for workers over 50. Conversely, the contribution limit for a traditional IRA or Roth IRA is much lower, currently set at $6,000 a year for workers under the age of 50 and $7,000 for workers over the age of 50.

Another advantage of a solo 401(K) is that the self-employed can make catch-up contributions, which are additional contributions that workers over the age of 50 can make to their retirement accounts. These additional payments can help to pad out a self-employed worker’s retirement savings as they reach the pinnacle of their earning potential.

The Bottom Line

The self-employed must take their retirement planning into their own hands. By starting early, investing wisely, and taking full advantage of available retirement savings options, the self-employed can set themselves up for a comfortable retirement. However, the trick to proper retirement planning is to start early to allow their investments to grow.

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