How to save for retirement as a self-employed woman

 

If you are self-employed, or thinking of starting a business, saving for retirement may be on your mind. Employer-sponsored retirement plans are a benefit of working for someone else. But you don’t want to work for someone else! Fantastic! Working for yourself also means setting up your own retirement plan, which is very do-able. There are a few options for self-employed retirement savings.

Save into an IRA

Since you are not participating in a 401(k) or other employer plan at work, you are likely eligible to save money into an IRA, which gives you tax advantages. An IRA is not specific to self-employment, it’s available to anyone who meets the criteria.

An IRA is simple to open but contribution limits are low.

The contribution limit for Traditional IRAs in 2022 is $6,000 per year; or $7,000 per year for people 50 and older. Contributions are usually tax-deductible. For those with lower household income, there’s also a Roth IRA.

An IRA is a good option for self-employed retirement savings when you’re just starting out, your income is low, and you don’t have a lot to save.

Open a SEP-IRA

SEP stands for simplified employee pension. In practice, it works much like an IRA but allows you to save up to 10 times more! A SEP is only for self-employed people or business owners and works best if you have no employees.

SEP IRA annual contribution limits cannot exceed the lesser of:

• 25% of compensation
• $61,000 in 2022

(If you’re self-employed, compensation = net self-employment income. The calculation gets a little dicey and it’s best to have an accountant calculate it for you. But just for fun, I’ll tell you it ends up at 18.59% of net income.)

SEP IRAs are about as simple to open as a regular IRA. The downsides are: 1) calculating the annual contribution amount can be complicated, 2) there is no Roth version of a SEP IRA, and 3) no catch-up contribution over age 50.

Overall, SEP IRAs can be an excellent choice for self-employed retirement savings. They often strike the right balance of simplicity and higher contribution limits.

Start an Individual 401(k) Plan

The Individual 401(k) – or Solo 401(k) – is for a business owner with no employees, although you can use it to cover your spouse. It’s more complicated to set up and requires periodic maintenance.

Contribution limits are higher than a SEP IRA, in part because there are employee and employer contributions – even though you are just one person playing both roles!

Overall contribution limit is $61,000 in 2022, plus additional $6,500 for age 50+, comprised of:

• Employee contribution: $20,500 in 2022, or 100% of compensation, whichever is less. (Plus additional $6,500 for age 50+.)
• Employer contribution: Additional profit sharing contribution of 25% of compensation or net self-employment income.

This looks more like the 401(k) you used to have at work. You can contribute up to $20,500 of your salary (as long as you made at least that much) plus your employer can contribute on top. In this case, the employer is also you.

I find the Solo 401(k) useful in two scenarios. 

1. If your business is earning good income, this plan lets you contribute the most, the fastest. 
2. If your spouse earns a lot and you are not reliant on your business income to live. A Solo 401(k) may allow you to save most or all of your business income for retirement, and give your family extra tax advantages.

(If you have employees, you should seek guidance from a professional when setting up any retirement plan.)

Choose the self-employed retirement plan that’s best for you right now

Starting your own business can be a life-affirming choice and something many clients come to during the Life Planning process. With self-employment comes flexibility, autonomy, and freedom from the paternalistic structure of a corporation. But with that freedom comes responsibility to do for yourself all the things the company was doing for you. I think the trade-offs are absolutely worth it.

Keep in mind, choosing a retirement account or plan that works for your business today does not lock you into that choice forever. If you start a SEP IRA today, that does not preclude you from adopting an Individual 401(k) next year.

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If you’d like help choosing a retirement savings option, click to learn more about Pearl Financial Planning. We help professional women build wealth and dream big.