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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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Keep it Going: Sustaining Your Success

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OMG you did it!! The months and years of working hard and working smart, of knowing when to listen to your inner voice and when to listen to a good adviser, the months of living on four hours of sleep and no vacations for what seems like forever and—–your company grossed $1 million over four consecutive quarters! You’ve reached a milestone that defines success.

OK. So now that you’ve reached the mountaintop, you have to figure out how to keep your footing and stay up there.  In fact, because you are focused, ambitious and determined, you’re already thinking about climbing even higher.  But sustaining and growing your success might demand as much work and determination as you invested to attain it. Here are four commonsense choices that can help you hold on to your earnings and continue the positive slope of your company’s future.

Pay taxes

Meet with a business accountant and figure out how much money you should reserve each quarter for tax payments (usually 30% – 40%). You don’t want to wait until the annual tax time and realize that you owe big money to the IRS.  Before you spread money around, pay the quarterly tax bill and set aside enough to ensure that all remaining tax bills in the calendar year can be covered.

Smart celebration

When you hit the revenue milestone that you’ve defined as your “made it” metric, whether the amount is a net or gross figure, you owe it to yourself to celebrate. What’s important, though, is not only how you celebrate but also with whom.

First, don’t overspend.  If you want to take a week-long spa vacation then go for it, because that will dissolve your stress and prepare you for the work you’ll do to build on your new-found success.  Or maybe you’d like to visit a place you’ve always wanted to see, or return to?  A splurge that refreshes and replenishes your energy stores is likewise always worth it.

Where you want to be careful is the amount you spend on consumer goods.  You may need a new car and if you can afford it, then do so, but be careful about splurging on luxuries.  Buying a Saab or Volvo probably makes more sense than buying a BMW or Benz at this point.  Save real luxury purchases for when you’ve raised your net worth to a more substantial level.

Others may want to throw a party.  Caution is advised when developing the guest list.  The sad fact is that there will be certain individuals, including family members, who will feel more envy than happiness upon hearing news of your success.  If a party is a must-do (and why not?), invite only those who supported and believed in you.

Fair-weather friends, frenemies, passive-aggressives, or critical types who claim that they’re just playing “devil’s advocate” or being “objective” are mostly about undermining and sabotaging. They are not your friends, even if they’re family members.  Don’t invite them and don’t let your mother guilt you into including them.  They don’t belong.

Save money

After you’ve paid down or, ideally, paid off any significant debts, business and personal, it’s time to save money.  Start with your retirement fund. Research options available to you in accordance with the business you own and pay the maximum amount allowed by your age and income level.  Investigate opening a Roth retirement account as a place to hold after-tax money if you anticipate having surplus cash.

Once you’ve figured out your retirement fund strategy, focus on other long-term investments. By all means, invest in the equipment, staffing, technology and office or manufacturing space that will support operations (including customer service), generate ROI and advance the business. But what if the building where you lease space comes up for sale? It might be a good move to buy the building, so that you can control your costs more effectively and also collect some rents.  For that, you’ll need money and a good credit score.

You can give yourself a wish-list savings account to build up cash reserves. There are other investments that can be made as well and to learn about your options, ask people you trust to recommend an investment counselor.  If you’ve got even $5000 to invest, investigate certificates of deposit, online banks such as Everbank, index stock funds, or actively managed mutual funds.

Keep doing what it was that made you successful

Now that you have a blueprint for making lots of money, continue to follow the template and don’t slack off! Don’t think that once you reach a certain level of success that things will just cruise along on their own. You must continue to do those things that created the conditions for success.  You can, however, devise methods that help processes become more efficient—that comes from experience. Operational efficiencies make money.  Plan your work to give priority to income-generating activities, such as sales calls and networking, to conserve your energy and bolster your stamina and creativity.

Thanks for reading,

Kim

Image: Emanuel Leutze (1816 – 1868, Germany) Washington Crossing the Delaware (River) December 25- 26, 1776 (1851)

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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