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Saving for Retirement Gets Easier

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Many Americans are unable to adequately save for retirement–or for any other reasons, including emergencies and post-high school education, unfortunately. Rising prices and decades of stagnant wage growth have contributed to both the inability to cover more than basic living expenses and increasing debt. It’s a recipe that undermines saving for the future.

This is not to say that Americans don’t understand the need to save for retirement. Just about everyone knows that once you’ve retired, Social Security cannot replace your entire annual income for the rest of your life. This sometimes results in a cash-flow gap for retirees that until the early 1980s was usually remedied by an employer sponsored defined annual pension benefit but thereafter, most employers chose to address the shortfall with a 401(k) plan. The difference is huge.

A defined pension pays recipients a specified monthly benefit at retirement. The employer funds the plan by contributing a regular amount, usually a percentage of the employee’s pay, into a tax-deferred account. Depending on the plan, employees may also make contributions. Typically, pensions are calculated through a formula that considers the employee’s salary and length of service.

The 401(k) plan, and also the 403(b) plan, by contrast, are defined contribution plans, as are employee stock ownership and profit-sharing plans. A defined contribution plan does not promise a specific amount of benefits at retirement. In this scenario the employee, the employer, or both contribute to the employee’s retirement account, often at a set rate, such as 5 % of annual salary each year. The employer usually works with a major financial services company that invests the retirement funds on behalf of company employees. Upon retirement, the employee receives the balance in the account, which is based on contributions plus or minus investment gains or losses. The value of the account will fluctuate due to changes in the value of the investments made.

The defined pension plan has nearly disappeared from the American landscape. For the most part, only city, state and federal government agencies offer a traditional pension plan to employees. Although we’ve had about 40 years to adjust to the next wave of retirement funding, the update has been a challenge. According to a survey published last October by the financial services company Bankrate, 56% of working Americans reported that they’re behind on their retirement savings goal. Furthermore, the general savings rate for Americans has fallen to an all-time low, according to the Bureau of Economic Analysis. The average American had saved 2.3 % of disposable income as of October 2022, down from a 7.3 % savings rate reported in 2021—but that figure was impacted by the pandemic, when people couldn’t get out and spend. Those are very disquieting statistics but in December 2022, Congress approved legislation that should provide a ray of sunshine to brighten the day.

The Setting Every Community Up for Retirement Enhancement (Secure) Act 2.0 Act is intended to change at least two depressing and embarrassing statistics: first, that nearly 75 % of small businesses do not offer retirement plans to their employees and second, to grow the percentage of Americans who not only contribute to a retirement plan but also encourage and enable them to start saving for retirement earlier in life. The idea is to allow retirement savings to grow over a longer period of time and result in a more financially secure retirement for you.

401(k) automatic enrollments

The enhanced rewards that come from saving for retirement will take time to kick in. Beginning in 2025, small businesses will be required to automatically enroll employees in 401(k) or 403(b) retirement plans, with a contribution rate between 3 % and 10 %. The employee contribution limit for 401(k) plans will be raised from $19,500/year to $26,000/year to encourage and reward more robust retirement savings, per Secure 2.0. Also, employers must offer retirement plan benefits to part-time employees who’ve worked for them for at least two years. Businesses that are less than three years old, or those that employ 10 or fewer employees, are exempt. Moreover, employers must explain to employees that they may opt-out of the auto-enrollment feature (maybe the spouse has a better retirement plan).

Another new feature of Secure 2.0 is the Starter 401(k), designed for small companies that currently do not offer a retirement plan to employees. The Starter 401(k) is not subject to year-end nondiscrimination testing (an additional compliance measure that examines if a business is fairly distributing its plan) and caps annual contributions at the same amount as the Individual Retirement Account (IRA) limit. The maximum contribution for an IRA account was $6,000 in 2022 and $7,000 for those older than 50.

Tax credits sweetener

Many options in the retirement benefits market haven’t been accessible to small businesses because private sector plans were designed to serve companies with 100 + employees but finally, SMBs will receive additional relief from costs associated with offering retirement plans through Secure 2.0. Previously, employers with fewer than 100 employees were eligible for a three-year, start-up tax credit that covered up to 50% of administrative costs, with an annual limit of $5,000. The new law has increased this credit to 100% of qualified start-up costs for new plans sponsored by employers with up to 50 employees. While costs to start retirement plans vary on the basis of a business’s size and the type of plan, the enhanced tax credits should cover a majority of an employer’s out-of-pocket costs for the first three years.

In addition to addressing the larger national economic issue of retirement savings, Secure 2.0 confers yet another advantage to SMBs—an opportunity for to improve their benefits package, which can attract talent. Benefits can be a competitive advantage when it comes to hiring, whether you operate a neighborhood breakfast and lunch place or a medical equipment company.

Retirement Plans for Freelancers

You didn’t think I’d leave you out of the mix, did you? Here’s an overview of tax-deferred and after-tax retirement savings plans that work well for Freelance professionals. Most feature similar options to save for retirement as employees participating in company plans.

Simplified Employee Pension (SEP)

  • Contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $66,000 for 2023 ($61,000 was the 2022 limit).
  • Open a SEP-IRA through a bank or other financial institution.
  • Set up the SEP plan for a year as late as the due date (including extensions) of your income tax return for that year.

401(k) plan

  • Make annual salary deferrals up to $22,500 in 2023 ($20,500 was the 2022 limit), plus an additional $7,500 in 2023 ($6,500 in 2022) if you’re 50 years or older either on a pre-tax basis or as designated Roth contributions.
  • Contribute up to an additional 25% of your net earnings from self-employment for total contributions of $66,000 for 2023 ($61,000 was the 2022 limit), including salary deferrals.
  • Customize your retirement plan to allow access to your account balance through loans and hardship distributions if you must.

A one-participant 401(k) plan is sometimes referred to as a solo-401(k) or individual 401(k). It is generally the same as other 401(k) plans, but because there are no employees other than your spouse (if s/he works for the business), the plan is exempt from discrimination testing.

If you are a Schedule C a sole proprietor and have a SIMPLE IRA plan, you are treated as both an employer and an employee when calculating and reporting your own retirement plan contributions and limits. Report both your salary reduction contributions and employer contributions (non-elective or matching) for yourself on Part II – line 15 of Form 1040 Schedule 1. Note that this is different from reporting employer contributions (non-elective or matching) for your employees, which you record as a business expense on Schedule C.

Maximum annual contribution SIMPLE IRA

Re: your salary reduction contributions, you may defer up to $15,500 in 2023 ($14,000 was the 2022 limit) however, you may not exceed your net earnings from self-employment from the business sponsoring the SIMPLE IRA plan. If you are age 50 years or older , you can make a catch-up contribution of up to $3,500 in 2023 ($3,000 was the 2022 limit).

When you are an employer

Employer contributions for yourself must be the same type and rate as the contributions you make for your employees. You must either:

  • match your salary reduction contributions dollar-for-dollar up to 3% of your net earnings from self-employment; or
  • make a non-elective contribution of 2% of your net earnings from self-employment that do not exceed $330,000 in 2023; ($305,000 was the 2022 limit).

Thanks for reading,

Kim

Image: Enjoying retirement at Seabrook Island, near Charleston, SC

 

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Dates to Keep You Straight

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Every year, Freelancers have an important list of dates to remember and act on, primarily those related to tax filings, retirement account management and health insurance plan enrollment. To help you stay organized, I’ve compiled this date planner that brings together all deadlines into one document that you can bookmark, copy into your calendar or even print out and post on your refrigerator.

TAXES

January 31, 2019: 1099-MISC due to contractors
Those who hired Freelancers (independent contractors) to whom they paid $600 or more in the previous year must send 1099-MISC forms by January 31, 2019.  If a client paid you less than $600, then you probably will not be mailed a 1099-MISC, although the IRS nevertheless requires you to report all income.

Do keep scrupulous records of who owes you a 1099-MISC so that you can accurately report your income on your tax return.  Your clients will also send 1099-MISC data re: you to the IRS and any differences between your numbers and the clients’ could trigger an audit.  If you haven’t received a 1099-MISC from a client by January 31, contact your client ASAP and request a re-send.

If you used any subcontractors to whom you paid at least $600 last year, you must likewise send them a 1099-MISC by January 31.

April 15, 2019: Individual income tax filing deadline
You have until April 15, 2019 to file your Form 1040 individual income tax return for 2018. Be aware that April 15 isn’t the deadline to pay your taxes — tax payments for Freelancers are due on a quarterly schedule (see 2019 quarterly estimated tax deadlines, below). If you wait until the tax filing deadline to pay your taxes, the IRS may charge you penalties and interest on top of the tax you owe.

If you’re still waiting for information, or you’re too busy to file a return by April 15, you may apply for a six-month extension that gives you until October 15, 2019 to file. The extension application needs to be filed by April 15, 2019. Remember again that the extension is for filing, not paying your taxes.  Payments are still due on the quarterly schedule no matter when you file and penalties and interest can accumulate if you wait to pay.

QUARTERLY TAX FILING DATES

The IRS requires business owners to pay income taxes on a quarterly schedule. This may seem like a hassle, but it’s easier to pay in four installments than to try and come up with a whole year’s worth of income taxes all at once.

Here are the 2019 deadlines for quarterly estimated tax payments. Note that the four quarters are not of equal lengths: the 2nd Quarter covers only April and May, while the 4th Quarter covers the last four months of the year.

DEADLINE                                                         PERIOD COVERED

April 15, 2019                                                     January 1 – March 31, 2019

June 17, 2019                                                      April 1 – May 31, 2019

September 16, 2019                                           June 1 – August 31, 2019

January 15, 2020                                                September 1 – December 31, 2019

 

RETIREMENT ACCOUNTS

April 15, 2019: Deadline to set up and contribute to an IRA for 2018
Even if you made no contributions to your retirement savings account in 2018, you can still make a 2018 contribution to an IRA up until April 15, 2019. This includes traditional, Roth and SEP IRAs. You can also make 2019 contributions to these plans from now up until next year’s tax filing deadline of April 15, 2020.

December 31, 2019: Deadline to set up an individual 401(K) 
An individual 401(K) is another type of plan that Freelancers can use to save for retirement. One important detail is that an individual 401(K) must be established by December 31st of the first plan year (as opposed to an IRA, which can be opened up until April 15 of the following year). That means it’s too late to set up an individual 401(K) for 2018, but you may set one up for 2019.

Contribution limits 2019 update:

Solo 401(K)                                                                                                                            Employer: 20% of net self-employment income                                                            Employee: 100 % of earned income up to $19,000 (for age 50 years +, up to $25,000)   Total combined contribution: $56,000

Traditional or Roth 401(K)                                                                                                     $6000 annually $7000 if age 50 years +

SEP IRA                                                                                                                                               The lesser of 20% of net self-employment income, or $56,000 annually

 

HEALTH INSURANCE

The open enrollment dates to purchase health insurance for 2020 on the Affordable Care Act exchange will be November 1 – December 15, 2019.  Open enrollment for 2020 through the national health insurance exchange will also be run from November 1 – December 15, 2019.

 

Thanks for reading,

Kim

 

 

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Exit Strategy: The Retirement Plan

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According to the Bureau of Labor Statistics, 15 million Americans were self-employed in 2015. That’s 15 million talented, ambitious, disciplined and self-confident citizens of our nation who’ve taken charge of their professional and financial future and they (we!) are to be congratulated.  According to the Bureau, self-employed business owners and Freelancers represent 10.1% of the population and they are surely the Talented Tenth.

Now for the bad news—self-employed professionals are not eligible for employer-sponsored benefits of any kind, unless they employ full-time workers and are therefore compelled to provide certain benefits that they would also receive.   Otherwise, the 15 million self-employed do not receive paid sick time, holiday time, vacation time, or employer cosponsored health insurance or retirement benefits.  In addition to the self-employed, there are many more millions who work in traditional employment on a part-time basis only, making them unable to receive employer-sponsored worker’s benefits.  Income inequality, anyone?

Let us consider the retirement fund matter, one of the two benefits issues that workers are able to self-fund (health insurance is the other).  If your finances allow you to set aside money that will be used to support you when you’re too old to work,  you will be wise to do so ASAP.

Examine your spending patterns.  How much are you spending on items that you want, but don’t need?  I don’t recommend that you deny yourself all gratification—we all deserve little luxuries every now and again—but some activities and purchases might perhaps be scaled back, allowing those funds to be redirected to prudent investments.

Budgeting a limited income is stress-producing.  Even those who work full-time may be forced to under-fund their retirement accounts, despite the employer matching contributions.  Wages have stagnated for 30 years and living expenses have done nothing but increase.  As a result, many of us are unable to save enough money.  Many elect to utilize money they’ve managed to save for a down payment on a house, rather than saving for retirement.  Financing one’s life 20 or more years from now must take a back seat.

According to the Government Accountability Office,  in 2015, approximately 50% of Americans had no retirement account whatsoever and 29% of those age 55 and older had neither retirement savings nor a pension.  Social Security is not a good fall-back option. The average monthly pay-out to retirees is only about $1294.  For the overwhelming majority, that’s not enough to carry one through more than half a month.

I consider the retirement picture in the U.S. as both a looming national emergency and a national embarrassment.  Corporate governance laws enacted during the administrations of Ronald Reagan, Bill Clinton and George Bush (son) that brought us globalization and the transfer of good paying jobs to other countries, in the process destroying for all time the ability of so many American citizens to earn a comfortable living employed in benefits paying full-time jobs, is the primary reason for this crisis.

The computer age has done the world no favors, either.  So now you can play with Snapchat on your Android while on break at your $12/hour job.  Yes, there have been magnificent technological advances that have helped in many fields, medicine comes to mind.  But are those benefits worth the livelihood of millions?  That’s a good question for the ethicists.

If at all possible, please start a retirement account.  Here are two options for Freelancers and those who work part-time at one or more locations:

myRA is a starter retirement account created by the Department of the Treasury. There are no fees associated with opening a myRA account and you can decide how much you’d like to contribute each month, according to your budget. Automatic withdrawal contributions can be set up through your bank account or paycheck.

If you change jobs, the myRA account is not affected. If you must take money from the account, there is no financial penalty to pay and no additional taxes are taken out. Like a Roth IRA account, myRA is funded with after-tax income. The maximum annual myRA contribution is $5500 and $6500 for those age 50 or older. The maximum amount that can be held in a myRA is $15,000.  Once the $15,000 limit has been reached (or before, for that matter),  the balance can be rolled over into a traditional retirement account.  https://myra.gov

Self-employed 401(k) profit sharing-plan (Solo 401 [k]) is funded with pre-tax dollars.  You can make contributions as both an employer (because you employ yourself) and as an employee (because you are employed by your sole proprietorship or single person LLC entity). Wearing your employer hat,  one contribution can be up to 25% of annual net profit, or $33,000 ($39,000 if 50 years or older) per year .  A second contribution of maximum $18,000 annually ($24,000 annually for those 50 years and older) can be made while wearing your employee hat.

Better still,  it’s possible to hire your spouse as an employee under this plan and s/he can contribute in the same way as you do,  meaning that your spouse can also contribute up to $53,000 ($59,000 if age 50 years or older) per year .  Open your Solo 401(k) account before December 31 if you’d like to make a tax-deductible contribution this year.

Thanks for reading,

Kim

 

 

 

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Year-End Tax Planning: Freelancer Options

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It’s never too early to start a retirement plan and Freelance consultants are encouraged to set aside money whenever possible.  Be advised that contributions to a self-funded retirement plan are guided by your net earnings from self-employment.  If you net $80,000 this year,  then you may contribute 20%  of that amount,  or $16,000,  to a SEP IRA or Solo 401K plan.  If you are age 50 +,  a  “catch-up”  contribution of maximum $5,500  (in 2014)  can raise your total allowed retirement fund contribution  (and tax deduction)  to $21, 500.  The maximum amount that one can contribute in tax year 2014 is $52,000 and $57,500 for those age 50 +.  However,  if you are a high earner and you consult with a savvy tax specialist,  it may be possible to divert lots more tax-deductible dollars to a Solo 401K than is allowed with a SEP IRA.

 

SIMPLE IRA

The Savings Incentive Match Plan for Employees Individual Retirement Account is a type of traditional IRA that is tailored for small business owners and self-employed Freelance consultants.  As with a traditional IRA,  contributions are tax-deductible and savings held in the account are tax-deferred until retirement withdrawals are made  (age 59 1/2 the youngest and age 70 1/2 the oldest).  If you have employees,  they may contribute to the SIMPLE IRA themselves and you the employer are required to make annual contributions as well,  whether or not the employee chooses to contribute.  You may make a 100%  match of the employee’s contribution,  but the maximum is 3% of your  net earnings,  or you may limit your employer contribution to 2%  of your  net earnings.

Any business entity that employs 100 or fewer workers may establish a SIMPLE IRA for employees and the owners,  too.  If you anticipate growth in your business that will likely cause you to hire even one full-time employee,  then consider a SIMPLE IRA,  because adding employees to the plan is relatively easy,  unlike other retirement plans.  The big downsides to SIMPLE IRA are 1).  the $12,000 annual contribution limit is considerably lower than that of SEP IRA and Solo 401K and 2). the  $2,5000  “catch-up contribution”  for Freelancers and business owners who are age 50 + is paltry by comparison as well.

However,  as a business owner or self-employed Freelance consultant,  you are your own employer and you may contribute to your SIMPLE IRA as both employer and employee.  You may add in up to 3% of net earnings,  in this example up to $2,400,  to contribute $14,4000 in 2014 and $2,500 extra if you are age 50 +.  Finally,  if you don’t make much money but you still want to set aside a little something for retirement,  if your net earnings from self-employment are $12,000 or less,  you may contribute 100% of the amount of your net earnings to your SIMPLE IRA.

ROTH 401K

A designated Roth Retirement Account is an individual retirement account that exists under the umbrella of your 401K,  solo or traditional  (if the 401K is set up to allow it).  Unlike SEP and Solo 401K,  Roth 401K contributions are made with after-tax income and when you are ready to access the account,  you will draw down tax-free money.   The 2014 maximum Roth 401K contribution is $5,500  ($6,500 for those age 50 +).

Your selection of a Roth designation within your 401K will depend upon your financial circumstances and you should meet with a reliable financial adviser in advance.  An individual or couple might choose a Roth when there are insufficient deductions to itemize at tax time,  thus negating the tax deduction benefit of the other retirement accounts .  The Roth,  paid with after-tax dollars,  gives account holders the benefit of tax-free income during retirement.   Wealthy Freelance consultants who are concerned about minimizing taxes during retirement may also benefit from the Roth.

You may have both a  (pre-tax)  Solo 401K and an  (after tax)  Roth 401K and it is permissible to use the salary-deferred portion of your Solo 401K to make a Roth 401K contribution.  Profit sharing Solo 401K contributions are not eligible to be made as a Roth 401K contribution,  since they are made pre-tax and are tax deductible and you cannot commingle the two.

While Roth 401K income-deferred contributions are NOT tax-deductible,  withdrawals made after age 59 1/2 are tax-free IF five years have passed since your first contribution to the Roth  (known as the 5 year rule).  One is NOT required to take distributions at least by age 70 1/2 and that feature may be useful for retirement cash flow planning.

Thanks for reading,

Kim

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Year-End Tax Planning: Funding Your Retirement

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Happy November.  The year will soon end and it is time to put together a tax planning strategy while there is still time to plan and execute.  There may be business equipment to purchase,  upgrades to make to your website or a seminar to attend,  but we self-employed workers must also fund our retirement.  Traditionally employed workers must also fund their retirement,  but they get help from their employers.  Freelancers are our own employers and we must step up and do all that we can to stash a few tax-deductible dollars in the cookie jar,  so that we can eat when we’re 75.

Whether you’ll squeeze a few thousand dollars out of modest billable hours or you’re looking for a place to roll the overflow from a lucrative year,  saving for retirement is a superb tax planning strategy.  It is also a superb life planning strategy.  Under no circumstances do we want to be old and broke in America.  If one is single,  that is a real possibility.  This is not Europe and the government will not give us any financial assistance in a time of need,  even though we have been tax paying citizens our entire lives.

The good news is that there are good retirement plan options available to Freelancers with a few thousand dollars to spare and the discipline to save.  Also,  the retirement money can be invested in stocks,  bonds,  mutual funds or even real estate.  You might get lucky and see your investment really grow.  Taxes will not be paid until it’s time to draw down on the account  (age 59 1/2 the youngest and age 70 1/2 the oldest).

SEP IRA

The Simplified Employee Pension Individual Retirement Account is modeled after the IRAs that every employer offers.  They are evidently the easiest type of retirement account to set up and there are minimal IRS reporting requirements involved.  Your job will be to find a brokerage firm that will set up the plan,  process your deposits,  maybe give you some investment advice and not kill you with administration fees.

Contributions are limited to 20% of your net earnings  (before the self-employment tax).  Contributions are capped at $52,000/year for tax year 2014 and the limit will increase every year or two,  to adjust for inflation.  A married couple who run a business together,  or are each Freelancers,  may open a joint account and save an annual maximum of $98,000 tax-deductible retirement dollars in 2014.  One cannot borrow against a SEP IRA.

SOLO 401K

The Individual 401K is modeled after a traditional 401K and once again,  the IRS filing requirements are uncomplicated and your job is to find a brokerage firm that will set up the plan,  process your deposits and not kill you with administration fees.  One may contribute money a little differently to a Solo 401K,  in that you may give yourself a  “salary deferral”  in a good year and stash up to 20% of your net earnings into the Solo 401K,  but the annual maximum contribution remains $52,000 in 2014  (the limit will rise modestly to adjust for inflation).  However,  Freelancers aged 50 +  can take advantage of the  $5,500 (max)  “catch-up contribution”  feature,  which allows those who are able to set aside more retirement dollars to do so and contribute up to $57,500/year in tax-deductible dollars.  Another big advantage of the Solo 401 K is that one may borrow against maximum one-half of the assets  (you must repay the loan with interest, to yourself).  Additionally,  a married couple who run a business together can start a Solo 401K retirement plan for the two and contribute up to $98,000 annually as of 2014 and $10,000 more with the catch-up contribution if both are age 50 +.

Next week,   we’ll look at the SIMPLE IRA and more retirement plan options.

Thanks for reading,

Kim

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2011 Year-End Tax Planning

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It’s about that time,  folks.  2011 ends in 7 weeks and it’s time to plan how to handle your taxes.  We all have to pay something  (except if you’re a multimillionaire or billionaire, in which case you pay nearly nothing!),  so before December 31 it’s important to enact a strategy that will work well for you.

Tax planning boils down to either accelerating or deferring income or deductions.  In other words,  do you want to report and pay taxes on more money or less in 2011 and do you want more or fewer write-offs?  The road you follow will depend on many factors,  including what you did last year,  how much money you will make this year,  whether you expect to make rather more in 2012 because a big project will start then,  or you expect to make rather less next year because an important project will soon conclude and you have nothing big on the horizon.

Take a look at your 2010 tax forms and 3rd quarter 2011 P & L statement to see what your financials say about your options.  What do fixed and variable expenses look like?  That will impact your decisions about deductions.  What does net profit look like?  That will impact whether you choose to accelerate or defer income.

If you want to accelerate income,  start by collecting outstanding receivables.  Pick up the phone or send an email and ask clients to pay ASAP,  or at least before December 31.  Tell them it’s a tax-planning matter (it sounds so much more dignified than telling clients that you plain old need the money!).  If you’ve got a contract in the works,  ask for a bigger retainer.

If you opt to defer income,  perhaps because 2011 has been a good year and you’re not sure what 2012 will bring,  then wait until January to collect receivables and ask for a smaller retainer fee.  BTW,  it’s possible to defer up to 25% of your income through your Solo 401K and it’s tax-deductible.

If you need write-offs,  scout for year-end deals on office furniture,  computers,  iPads,  office supplies,  software and whatever else you need to do business,  including enrolling in a course or attending a conference.  Office furniture,  computers,  company vehicles and other big-ticket items can be written off in a lump sum,  or depreciated over a period of years  (which is in reality deferring the deduction since it’s being spread out).

If you elect for fewer write-offs,  hold off on shopping until the calendar turns.  Alternatively,  if you are presented with office or business equipment deals that you cannot refuse,  then choose the depreciation method and spread out your deductions.

Speaking of deductions,  remember your retirement plan.  Solo 401K and SEP-IRA are funded with pre-tax dollars and are tax-deductible up to $16, 500.00  If you’re 50+,  the catch-up contribution feature raises the maximum to $22,000.00.  Remember the tax-deductible income deferral feature if you’ve had a very good 2011,  but expect to have a less lucrative 2012.

Further,  you might want to make an appointment with your accountant or business attorney and confirm that you are enrolled in the best legal entity for you.  Your exit strategy can impact  the legal entity you use.   For example,  if you want to take on a partner and eventually sell out,  or pass the business to offspring,   niece or nephew,  a different legal entity may be preferable.

Finally,  the end of the year is the time to assess what’s happened this year for you,  professionally and personally. Review your successes and challenges.  What will you do differently in 2012 and what will you continue to do?  Did you meet your financial goal?  Did you manage to sign a dream client or get a wonderful proposal approved?  What should you reach for in 2012?

Thanks for reading,

Kim

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The Roth, The SEP and The Solo 

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As you begin to ponder your inevitable retirement from the Freelance life,  you’ll  need to examine options for saving.  Those who generate an income large enough to make planning and saving for the future an obvious course of action probably have an investment counselor to act as guide through the minefield.  

Yet at some point,  less wealthy Freelancers must also understand how to finance the next phase of their lives.  Choosing the best retirement plan option is confusing and subtle differences can magnify both at tax time and when it’s time to retire.  I hope that you find this post useful as you formulate the plan for your future.

The Simplified Employer Pension Plan

Somewhat similar to Solo 401K,  the SEP IRA retirement plan may be used by Sole Proprietors,  LLCs,   C  Corporations,  S  Corporations and Partnerships.  As an added bonus,  the SEP IRA may be used not only by those who have both W2 and self employment income,  but also by business owners who employ more than just the spouse.

Contributions to the SEP IRA are made pre-tax and contributions are tax deductible.  It is permissible to contribute up to 25 %  of W2 earnings plus up to 20%  of self employment income,  to the maximum annual contribution of $49,000.00 in 2010.  There is no  “catch up contribution”  provision with SEP IRA.

If you have a job,  including one where you are able to participate in a retirement plan,  along with a sideline business,  then SEP IRA is your option of choice.   Up to the maximum,  the amount you choose to contribute,  or even if you choose to contribute,  in a given year is up to you.  Contributions are held tax deferred and withdrawals made after age 59 1/2 are taxed as ordinary income.  Withdrawals made prior to age 59 1/2 are subject to the customary 10 %  premature withdrawal penalty and additionally,  will be taxed as ordinary income.

Small business owners with employees may institute a SEP IRA for themselves and their employees.  Business owners are able to make generous tax deductible contributions to the company SEP IRA on behalf of themselves,  the on-the-payroll-wage-earning spouse and other employees.

The business owner decides at what level to fund the plan,  up to 25%  of annual compensation.  The %  of funding for the business owner must equal what is offered to employees.  Each employee has an individual SEP IRA account and the business owner pays the entire contribution.  The pre-tax money paid into each SEP IRA account is tax deductible for the business and is a tax free benefit for the employee.

If you like,  it is possible to convert a SEP IRA to a Solo 401K,  something you may choose to do when you turn 50 and want to make those catch up contributions.  Other retirement accounts can be consolidated into the SEP IRA,  with the exception of a Roth  401K,  which is an after-tax fund.  It is not possible to borrow against the value of the SEP IRA.  April 15  is the deadline to establish and fund your SEP IRA account in order to receive a tax deduction for the previous year.

Roth 401K

 Unlike SEP and Solo 401K,   Roth 401K contributions are made with after-tax income.  Which option you choose will,  like most of life’s choices,  depend upon how much money you generate.  Depending upon your financial situation,  you may decide to split the difference and have both a  (pre-tax)  Solo 401K and an  (after tax)  Roth 401K. 

It is permissible to use the salary deferred portion of your Solo 401K to make a Roth 401K contribution.   Remember that the maximum annual contribution is $16,500.00  for those younger than 50 years and $22,000.00 for those 50 years and older.  Profit sharing Solo 401K contributions are not eligible to be made as a Roth 401K contribution,  since they are made pre-tax and are tax deductible and you cannot commingle the two.

While Roth 401K income deferred contributions are NOT tax deductible,  withdrawals you make after age 59 1/2 years are tax free IF five years have passed since your first contribution to the Roth (known as the 5 year rule).  Roth distributions must begin at least by age 70 1/2,  unless you roll over to the Roth IRA.

BTW,  if you transition into a job that offers a retirement plan,  you may be tempted to roll your SEP IRA or Solo 401K into the new retirement account.  Be advised that may or may not be a smart move.  Maintenance fees will be much lower for an account attached to a large company vs. that of an individual;  but there is much more investment flexibility available in your Solo 401K vs. what is available to a big corporation. 

Thanks for reading,

Kim