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Solopreneur Retirement Benefits

When you ventured into solopreneurship, you knew it meant being 100% all in on your business. You fulfill duties from the c-suite level to answering the phones and everything in between. Your days are spent working on your business as much as they are spent working in your business – serving as employer and employee.

Being a one (wo)man shop is more challenging than you anticipated, but you’re loving every minute of being your own boss and the freedom it allows. However, you can’t neglect your “boss duties” of yourself – retirement planning (if you missed the 'why' check it out in part I). It’s easy to get so caught up in the now of your business that you forget to plan for the future of you. But that’s why you’re reading this article – to see what your options are and how you can best plan for your future.

You may be thinking, “I don’t need to save for retirement, I’m going to work until I die and I’m not going to sell my business. My business IS my retirement plan.” But I caution you that even if you have no plans of selling your business in the future, you still can’t neglect your retirement. We can’t predict the future and as a savvy solopreneur you can’t afford NOT to plan for your retirement.

The simplest way to begin planning for your solopreneur retirement is with an Individual Retirement Account (IRA). There are two options: Traditional and Roth, and either can be opened with a wide range of custodians. Here are their differences:

Traditional IRA

A traditional IRA is funded with pre-tax dollars, meaning you don’t pay taxes on the money now but rather you defer them until you take the money out. When you begin taking retirement withdrawal from a traditional IRA, both your contributions and the growth of that money is taxed as ordinary income.

Generally, deferring taxes is most advantageous if you have higher income now than you will in retirement. This will lower your taxable income now while you’re in a higher tax bracket and leave taxes to be paid later when you’re in a lower tax bracket.

Depending on your age, even the tax savings now may not accumulate more than our next option, the Roth IRA.

Roth IRA

In contrast to the traditional IRA, your Roth IRA is funded with after tax dollars. You earn money and pay taxes on it now and then deposit it into the Roth IRA. When you begin taking withdrawals in retirement, both the money you deposited and the growth on that money is tax free.

Much of conventional wisdom says to contribute to a Roth IRA when you’re young because you’re likely making less money. But as your income goes up you can switch more to traditional funds to offset some tax burden. However, as mentioned above the tax savings of deferrals may not actually outweigh the tax impact on the distribution of the funds. This is where it’s worth having a sound financial plan to help you in deciding which is right for you.

SEP IRA

A Simplified Employee Pension (SEP) IRA is essentially a means of establishing a Traditional IRA for each employee. As you’re operating as a solopreneur, this would mean you’re setting one up for yourself. The SEP IRA is simple and more cost effective than a conventional retirement plan and it has different limits than a Traditional IRA.

With a SEP IRA, it’s technically only you as the employer that can contribute to the plan. In this case though, you’re both the employer and the sole employee. Also, because the SEP IRA rules are different, as the employer you’re allowed to contribute up to 25% of your pay (as an employee), up to the IRS defined contribution limits.

This plan is easy, cost effective, and flexible – you (as the employer) can choose each year how much to contribute based on cash flow. If, however, you’re planning on adding employees, check out the next installment of this blog for the rules of SEP IRAs for when it’s not just you.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA plan is available to small businesses with 100 or fewer employees. As a solopreneur, you fit the mold. Under this plan you have the option to provide an employer match up to 3% of your compensation as the employee, OR you can opt to do a 2% non-elective contribution, meaning you as the employer must contribute 2% regardless of your contribution as employee.

While this plan is simple to set up and is cost effective for small businesses, there is probably a better alternative for you as a solopreneur. The contributions are fairly inflexible, and it has lower contribution limits than some of your other options.

Defined Benefit Plan

Although it’s not as intuitive as it once was, a defined benefit plan’s structure is in its name: it provides a fixed, pre-established (aka ‘defined’) benefit plan for the employee in retirement.  However, this is one of the costliest type of plans, and one of the most administratively complex plans; and as you guessed – that equates to expensive.

For just your solopreneur self, there would have to be a significant benefit to outweigh the overhead of a defined benefit plan for yourself. If you’re considering this as an option, I HIGHLY recommend consulting an advisor (like myself – shameless plug  😊) who is well versed in this space and can run a detailed analysis to determine cost effectiveness. There are certainly scenarios where a defined benefit plan is optimal for a solopreneur, but it should be a part of a bigger financial planning process for best outcome.

Solo K/Single K Plan

The terms Solo K, Solo 401(k), Uni-K, 1-participant K, and Single K are used interchangeably for this type of plan, and in a nutshell, it has the same rules and requirements as a regular 401(k) plan you may have prior experience with.

There are both your contributions as employee (elective deferrals up to the IRS limits) and the employer contributions, but the employer contributions have a special formula you must use as a solopreneur to determine the limits.  

Which Solopreneur Retirement Plan is Right for Me?

The answer to which retirement plan is right for you will depend on your business, your goals, and your preferences. Regardless of which plan type you choose, I recommend consulting a professional to determine best course of action. What is right for you now, may not carry into what is right for the future of you and your business so you’ll want to be sure you’re set up as best as possible.

My team and I are always available for a consult, and if you’re particularly interested in learning about taking that first step from solopreneurship to small business owner (ie hiring an employee) stay tuned for the next installment of this blog where I’ll take you through the plan options for you in that scenario.

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