Money Rehab with Nicole Lapin - Retirement Roadmap for the Self-Employed: The Four Essential Plans You Have To Know

Episode Date: July 24, 2023

Being self-employed can be awesome; you have freedom and perks that are unique to the entrepreneur life. But, this career also comes with more responsibility to your #1 employee: yourself. Today Nicole goes through the four major types of retirement plans self-employed peeps should know about.

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money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. I'm Nicole Lappin, the only financial expert you don't need a dictionary to It's time for some money rehab. Being self-employed can be awesome. You have the freedom and perks that are unique to that entrepreneur life. But this career also comes with more responsibility to your number one employee, yourself. I got an email recently from a money rehabber who's new to the self-employment game and is wondering, WTF do I do about planning for retirement? Here he is. Hey, Nicole. My name's Ian, and I got laid off from a media company job late last year.

And since then, I've been doing some freelance work. At my old company, I had a 401k that they managed. But now that I'm self-employed, I'm not sure what I can do or what I should do to plan for my retirement. Thanks. Okay, Ian, I'm going to be real with you, as I always am. Accounting stuff and retirement planning are two of the most complicated parts of being self-employed. They're kind of the worst, but they're also both super important. Think about it this way. As a self-employed. They're kind of the worst, but they're also both super important. Think about it this way. As a self-employed person, you're hustling hard, you're building something awesome. You can't forget about your future self in the process, or what's it all for? So quickly talking to my money rehabbers who aren't self-employed for a minute,

you guys are probably getting the benefit of employer-sponsored retirement plans and can ask HR for some clarity if you run into questions on your plan. Us self-employed folk are HR and have to figure this stuff out on our own, which honestly is the story of being a business owner. But I've been through all of this, so I can walk you through it. Let's go through the four major types of retirement plans for self-employed people that you should know about. And yes, I am saving the best for last, so pay special attention to number four. Number one, Solo 401k. This plan is the best for business owners who do not have any employees on payroll and want to ball out on retirement contributions. You might have heard this plan called a Solo K or a Uni K or a One Participant K. It has a lot

of names, but Solo 401k is my favorite, so that's what I'm going to go with. Let's double click on the contribution limits. If you have a 401k through an employer like Ian used to have, your contribution limit for 2023 would be $22,500, and hopefully your employer is matching your contributions to some extent. If you have a solo 401k, you can basically double dip and make contributions as the employee and the business owner. The math can get a little hairy, but the big picture is that your maximum contribution limit is $66,000 for 2023, which is a significant jump from the $22,500 that you can contribute to a company-sponsored 401k. And you can also set up this account as

a traditional solo 401k or a Roth. Let me take a minute to unpack what differentiates any, quote, traditional account from its Roth fraternal twin. Traditional accounts you'll hear described as tax-deferred or pre-tax, and that means your contribution goes straight into your retirement account before getting taxed as income. Roth accounts are post-tax accounts, meaning your contribution gets taxed as income first and then goes into your retirement account. I'm going to use you as an example, Ian. Say Ian makes $75,000 from his business this year and wants to contribute $10,000 to his retirement account. If he opens a traditional solo 401k, he gets to scoot that 10 grand into the retirement account before it's counted as

taxable income, which also means that when tax season rolls around, he's only taxed on his income minus his retirement contributions. So in this example, it would mean that he's knocking his taxable income down from 75 grand to 65 to $65,000. And that's pretty cool, right? This means that your tax bill is going to be a little smaller. And if you're right on the edge of a tax bracket, your contribution might even bump you down to a more advantageous bracket. Let's put a pin in those perks for just a second and move on to the Roth. If Ian opens a Roth solo 401k, his contribution will be taxed first, and then he can make a contribution with that post-tax money. So in other words, he can still contribute 10 grand to his

retirement account, but all that $75,000 of his income is going to be taxed. So in other words, he can still contribute 10 grand to his retirement account, but all that 75 grand of his income is going to be taxed. He's not going to get the perk of being taxed on a smaller bucket of income. Okay, now we're back to the pin I told you I would put in a traditional 401ks. So no matter how you contribute to your retirement account, you're going to have to pay taxes on it someday. So while you get to put money into a traditional solo 401k before tax, all of the money that goes into the account does get taxed when you take it out. But with Roth accounts, because you already paid taxes on your contributions,

that's it. You are done. So when you withdraw the money from your Roth account in retirement, you don't need to pay taxes on it at all. All of that money is yours. So the question you really need to ask yourself is, would you rather pay taxes now or later? If it's your financial goal to make more and more money throughout your life, that might mean that you're in a higher tax bracket when you're older, which means you'll probably want to opt into Roth accounts when you can because your tax rates will be lower now than when you want to withdraw. With me? Okay, let's get to the next example. Number two, traditional or Roth IRAs. Aren't you glad we just did that whole Roth spiel? So even though both self-employed people and W-2 employees can create IRAs,

these accounts are usually recommended to entrepreneurs. But that's really a big oversight. Both traditional and Roth IRAs should really be thought of as supplementary, like bonus retirement accounts, because the contribution limits are the lowest of the low. In 2023, the total contribution limit you make to your IRAs can't be more than $6,500. And just a quick note here, that's the limit for contributions between both traditional and Roth IRAs. So if you have both a traditional and a Roth IRA, which you can totally do,

you can't contribute $6,500 to both. The contributions you make to each cannot exceed $6,500 total. That's literally a tenth of the contribution limit of a solo 401k. So just know that you're not going to be retiring in style from an IRA alone. So far, you're probably thinking, Lappin, 401ks, IRAs. These are all options I have heard of when I was an employee. And yes, these plans are kind of self-employed spins on familiar plans. So let's move on to the plans that are very specific to business owners. Number three, simple IRA. I remember when I first heard about simple plans, I thought, hey, sign me up. I want more simplicity in my life, obviously. But this plan didn't earn the nickname for being

straightforward or actually simple. Simple is an acronym. It stands for Saving Incentive Match Plan for Employees. This is a good option for business owners who do have a small group of employees. And this is actually the only option for business owners with a small-ish team. So if you have more than 100 employees, you can't open a simple IRA. Unlike solo 401ks and the other IRAs we just talked about, there's no Roth option for a simple IRA. Your contributions will always be pre-tax, and then they're taxed when you take the money out.

The end. The contribution limit is $15,500 for 2023, so more than double the vanilla IRA, which is pretty cool. But let's move on to what is probably the holy grail of self-employed retirement accounts. Number four, the simplified employee pension or SEP IRA. So this is a particularly good fit if you're a one-person show and can work if you run a smaller team, but more on that in a second. With SEP IRAs, you can contribute up to 25% of self-employment income up to a maximum of $66,000 in 2023. You might remember that this is the same limit as solo 401ks, but some people prefer SEP IRAs to a solo 401k because they're easier to set up, which is a totally fair reason for doing anything, especially when you're running a business. Unlike the solo 401k, SEP IRAs don't have a Roth option,

so again, contributions will always be pre-tax and then taxed when you take the money out. But here's the weird quirk about SEP IRAs. If you have employees, however you treat your own contribution, you have to give your employees the exact same treatment. In other words, whatever percentage you contribute from your comp to your SEP IRA, you have to contribute the same to your employee or employees. This is why if you have a bunch of employees, I would probably opt for a more simple IRA. The actual simple one,

but it's not super simple, but it's called simple. Capisce? For today's tip, you can take straight to the bank. And this is not just a tip, this is a must have. Don't approach these four options thinking that you have to choose the best one for you, because you can and you should mix and match. It's unrealistic to think that one retirement account is going to give you the dreamy retired life you want. So when you make your retirement roadmap, think of what combination of these accounts is going to get you there. Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin.

Money Rehab's executive producer is Morgan Levoy. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at Money News and TikTok at Money News Network for exclusive video content. And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make. Thank you.