Our country’s workforce is evolving. Many of us are not only working from home, but working for ourselves. Others, while still holding down a job, have developed a second income stream on their own. And there are those who are transitioning from employee to self-employed. In fact, according to the U.S. Bureau of Labor Statistics, there are 9.886 million self-employed people in the U.S., about 6.3 percent of the total employed U.S. population. The varieties of self-employment are endless: building web pages for small businesses, grocery shopping for others, snow removal in the winter and yard work in the summer, social media management, tutoring kids, tutoring elders about technology, pet sitting.
Regardless how you’re doing it, if you’re earning a self-employed income, you can take advantage of a tax-advantaged retirement plan to shelter some of that income, to set some of those dollars aside for your future. Tax-deferred retirement savings are a win-win-win for the self-employed, a sole proprietor, or a small business owner, because you can build retirement savings and add to your investment portfolio while reducing your tax burden. There are a number of IRS-approved retirement plans designed for self-employed individuals, two of which are particularly advantageous in that they are easy to set up and cost little to maintain: a SEP IRA and a Solo 401k.
Simplified Employee Pension (SEP) IRAs
You can establish a SEP IRA—or contribute to an existing SEP IRA—for a previous year as late as the due date of your income tax return, including extensions. Setting up the plan is simple; you don’t need to work through a third-party administrator like a traditional employer-sponsored 401(k) plan. And you can contribute as much or little as you want each year within the contribution limit, which for 2022 is up to 25 percent of your self-employed income or $61,000, whichever is less.
From the moment you set up a SEP IRA and with each contribution, you are 100 percent vested in your SEP IRA, whatever amounts you contribute and whatever earnings those contributions produce. And you can contribute your deferral to a traditional pre-tax account or an after-tax Roth account.
One of the benefits of a Solo 401(k), so-called because it is a 401k plan for only one person, is that its contribution limits are usually the highest of the various types of retirement accounts. Like a regular 401k, part of the contribution comes from the employer and part from the employee. But in a Solo 401(k) you are both employer and employee and make both contributions.
For tax year 2021, you can defer up to $19,500 of self-employment income as your employee contribution, and up to 25 percent of your self-employment income or compensation as your employer contribution in your Solo 401k, up to a maximum of $58,000. People older than age 50 can contribute an additional $6,500, what the IRS refers to as a “catch up” contribution, plus the 25 percent of self-employment income for a maximum of $64,500. For 2022, the limits increase to $20,500 plus 25 percent up to a maximum of $61,000, or with the catch-up contribution, $67,500 for individuals over 50.
Like the SEP IRA, you can contribute your deferral to a traditional pre-tax account or an after-tax Roth account. Unlike the SEP IRA, you must establish a Solo 401k during the tax year you’re taking the deduction. Both plans allow you to start taking distributions without penalty after age 59-and-a-half, and both require minimum distributions after age 70-and-a-half.
Managing your money is important, as is focusing on your long-term as well as your short-term financial goals. As your self-employment income grows, setting some of it aside into a SEP IRA or a Solo 401k will help you maximize the long-term financial benefits of your self-employment.
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
Any investment involves some degree of risk, and different types of investments involve varying degrees of risk, including loss of principal. It should not be assumed that future performance of any specific investment, strategy or allocation (including those recommended by HBKS® Wealth Advisors) will be profitable or equal the corresponding indicated or intended results or performance level(s). Past performance of any security, indices, strategy or allocation may not be indicative of future results.
The historical and current information as to rules, laws, guidelines or benefits contained in this document is a summary of information obtained from or prepared by other sources. It has not been independently verified, but was obtained from sources believed to be reliable. HBKS® Wealth Advisors does not guarantee the accuracy of this information and does not assume liability for any errors in information obtained from or prepared by these other sources.
HBKS® Wealth Advisors is not a legal or accounting firm, and does not render legal, accounting or tax advice. You should contact an attorney or CPA if you wish to receive legal, accounting or tax advice.