Retirement
Planning
for the
Self-Employed
Table of Contents
Introduction .......................................................................................3
Take Stock of Your Present Situation .....................................4
Retirement Benefit Plans for the Self-Employed .............8
Common Retirement Planning Errors ...............................11
The Retirement Obstacles Created by SelfEmployment ....................................................................................16
Advantages of Being Self-Employed ...................................20
Conclusion .......................................................................................22
Retirement Planning for the Self-Employed
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Copyright © 2014
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Retirement Planning for the Self-Employed
Introduction
If you are employed by a company, one of the perceived
disadvantages of self-employment is the lack of benefits,
especially those involving retirement. Those who are selfemployed often bemoan the lack of retirement plans and
benefits available to them.
However, there are many retirement benefits available to
those who work for themselves. In some cases, these
benefits are better than those provided by some of the
biggest employers in the United States. There are also some
retirement planning advantages when you’re selfemployed.
Planning for your retirement can be a little more challenging
if you’re self-employed, but there are many great options
available to you!
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Retirement Planning for the Self-Employed
Take Stock of Your
Present Situation
Everyone’s financial situation is different. Understanding
your starting and ending points will permit you to make
more advantageous decisions. Many business owners fail to
consider these items early in their careers.
Ask yourself the following questions to gain a better
understanding of your financial situation and future
needs:
1.
How much is my net worth? People are frequently
obsessed with “net worth.” While it isn’t the only
concern, it is one measurement of financial health.
•
The process of calculating your net worth is one of the
most revealing financial exercises you can do because it
forces the examination of your debts, assets, and the
allocation of both. A detailed net worth analysis can
reveal a lot about your financial habits.
2.
What are the major expenses I face between now
and retirement? Some of these major expenses might
include paying off a mortgage, funding higher
education, and perhaps footing the bill for your
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Retirement Planning for the Self-Employed
daughter’s wedding. Of course, there are cars and
vacations, too.
•
Be sure to consider the possibility of unplanned
expenses. Medical costs in the US are the highest in the
world. Even minor operations can cost over $10,000.
3.
What will my expenses be at retirement? Is your
intention to have your home paid in full by the time you
retire or will you still be paying it off? Will you be
downsizing and paying rent?
4.
How much do I have invested? Some families have a
high net worth, but it isn’t invested effectively. You
might have an extremely expensive painting hanging on
your wall, but is that the best use of your money? In
most cases, the more money a family has invested, the
better off they will be when retirement arrives.
•
A million dollar home might be a great investment in
certain parts of the country. But the stock market has a
long history of returning an average of over 10%
annually.
•
5.
Ask yourself if your money is invested wisely.
How much debt am I carrying? Debt is more insidious
than most individuals realize. It’s like running a
marathon against the wind. When you have debt, it’s
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Retirement Planning for the Self-Employed
constantly subtracting from your financial growth and
future.
•
Most forms of debt are at a higher interest rate than
most investments pay. This is another way of saying that
paying off your debt is a better investment than an
actual investment!
•
A lack of savings or income is one of the biggest
determining factors of when you can retire. The other is
the amount of your debt. Any debt you have at
retirement will still need to be paid.
6.
Would I still like to earn money during my
retirement? For some, retiring means lying on the
beach all day. But others would prefer to work in a
modified fashion. That typically means part-time in a
new, fun, or rewarding capacity.
•
Even a part-time job can make a huge difference. Just
$10/hour at 20 hours/week might be enough to make a
mortgage or rent payment each month. If your housing
is already paid for, it can go towards food and utilities.
•
If your retirement planning is looking a little grim, a
part-time job can turn the numbers around!
How does your situation look? Do you have retirement goals,
and are you on schedule to meet them? It’s challenging to
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Retirement Planning for the Self-Employed
plan for the future if you’re struggling to keep the lights on.
Avoid falling into that trap by taking a good, hard look at
your financial situation. It’s difficult to reach your
destination if you don’t know where you are now.
“The trouble with retirement is that you never
get a day off.”
-Abe Lemons
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Retirement Planning for the Self-Employed
Retirement Benefit
Plans for the SelfEmployed
Sure, your friends that work for big corporations have fancy
benefits and 401k plans that their companies match. You
might think you’re limited to an IRA plan and a savings
account, but nothing could be further from the truth. The
government is looking out for you.
There are many options available to the self-employed that
can match up quite well to those of your friends in the
corporate world.
Consider these retirement plan options:
1.
Simplified Employee Pension IRA (SEP IRA). This is
likely to be the best option for many, especially if you’re
a one-person operation. With a SEP IRA, you can sock
away up to 25% of your net earnings! There is a limit of
$52,000 for 2014. These can be set up at nearly any
bank.
•
The fees are extremely low!
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Retirement Planning for the Self-Employed
•
The money and the earnings are sheltered from taxes.
The money is taxed at withdrawal, similar to a
conventional IRA.
•
This is actually better than a conventional or Roth IRA,
because the contribution limits are much higher.
2.
Savings Incentive Match for Employees (SIMPLE
IRA). This option is similar to the SEP IRA, but requires
that you match any contributions made by your
employees, up to 3%. The matching rules are
complicated, so investigate them. The maximum
contribution is $12,000.
3.
Individual 401(k). This is also referred to as a Solo
401(k). This is very similar to a Traditional IRA, but it’s
only for sole proprietors. That means you aren’t
allowed to have any employees, except your spouse.
•
Contributions are tax-exempt. Taxes are only paid when
the money is withdrawn.
•
This is a great way to save a lot of money for retirement.
With an individual 401 (k), you can contribute money as
both an employer and an employee.
•
The limits are $17,500 ($23,000 if you’re over 50 years
old), and an additional 25% of income as an employer.
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Retirement Planning for the Self-Employed
The total contributions cannot exceed $52,000 (if over
50 years of age). With a spouse, it’s double!
•
You can begin withdrawing the money at age 59 ½. If
you take an early withdrawal, there’s a 10% penalty.
However, there are some exceptions. Money can be
withdrawn early, without penalty, for several reasons.
These reasons include purchasing a first home, paying
for higher education, sudden disability, and the
prevention of foreclosure or eviction.
4.
Roth Individual 401(k). This is simply the Roth version
of the individual 401(k). So you’d have to contribute
after-tax money. However, no tax is due when the
money is withdrawn.
“I found out retirement means playing golf,
or I don’t know what the hell it means.
But to me, retirement means doing what you have fun doing.”
- Dick Van Dyke
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Retirement Planning for the Self-Employed
Common Retirement
Planning Errors
One great way to increase your odds of success in any
endeavor is to simply avoid the obstacles that make success
more elusive. Anticipate your missteps, so you can seek to
eliminate or avoid them altogether.
Are you making any of these retirement planning errors?
1.
Failing to invest consistently. If you want to see your
retirement savings grow, it’s important to continue
saving and investing each month. Those who are selfemployed often lack a consistent income. This can make
regular saving more difficult, but even more important.
When you have the income available, be sure you’re
planning for the future.
2.
Entering retirement with too much house. While
many couples downsize after the children leave, many
remain in a larger home. This can be a bad idea. While
real estate does appreciate, the rate of the appreciation
is usually much lower than stock market returns over
time.
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Retirement Planning for the Self-Employed
•
If possible, get rid of your big house and put the extra
money into your retirement account.
3.
Starting too late. Time is perhaps the most powerful
variable in retirement planning. If you haven’t started
yet, today is a great time to start working on your plan.
•
If you have some lucrative early years, it’s especially
important to take advantage of them when you’re selfemployed.
4.
Ignoring taxes and inflation. We’re all guilty of playing
with those savings calculators, and getting excited by
the numbers we see. Even in a tax-deferred account,
taxes will still have to be paid sometime. That fantastic
balance you see at the end of the rainbow is usually
only partially yours.
•
Inflation is the other value killer. Since 1913, inflation
has averaged 3.22%. If your stocks average 10% each
year, in most cases you’re only looking at 6.78% net,
before taxes!
•
Ensure that you’re taking advantage of tax-deferred
accounts as much as possible, so you’re only taxed once!
With a regular brokerage account, you’re using after tax
money, and you’ll be taxed on the profits, too.
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Retirement Planning for the Self-Employed
5.
Relying too much on social security. The long-term
health of the social security system is questionable.
While it can be a great supplement to retirement, you
ought to have other plans.
6.
Underestimating retirement spending. Many retirees
are surprised at how much money they spend after
retiring. But if you really think about it, it’s not
surprising. It’s very challenging to spend less during
your later years.
•
Those that are self-employed usually work very hard.
The hours are long, and you’re probably exhausted at
the end of the day. In many cases, you may lack the time
to go out to eat, hit the movies, or take many vacations.
•
When you’re retired and finally have some free time, are
you just going to sit around the house? You probably
want to play golf, go out to lunch, and do some traveling.
•
It’s very easy to spend more in retirement than when
you’re working 40+ hours per week.
7.
Lacking a good mix of investments. Interest rates are
currently very low, which means that fixed-income
investments aren’t paying much. Can you ensure these
safe investments will be better in the future?
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Retirement Planning for the Self-Employed
•
Historically, retirees were told to have 80% of their
investments in bonds. Experts are now saying that 50%
is probably a more fitting number.
8.
Overestimating how long you’ll be able to work.
Many people assume they’ll be able to work into their
70’s.
•
Can you be sure your health will permit it and will your
skills still be relevant?
•
Working as long as possible might sound like a good
idea now, but will you feel the same way in the future?
9.
Underestimating health care costs. It’s very typical
for retirees to have health care expenses that can run
$250,000 beyond what Medicare covers. Remember
that Medicare doesn’t cover dental, vision, or hearing
issues.
•
Most retirees underestimate health care costs, so be
realistic in your assumptions.
10. The inability to determine how long you’ll live. The
average life span is close to 80 years for both men and
women. If you’re 45+ years old now, your life
expectancy is in the mid-80’s.
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Retirement Planning for the Self-Employed
•
Did you know that if a couple retires at age 65, there’s a
50% chance that one of them will live into their
mid-90’s?
•
Will your retirement income last as long as you live?
Think about it. If you retire at age 65 and one of you
lives to be 95, that’s 30 years. You probably only worked
for roughly 40 years. That’s a lot of years to support.
Avoiding these missteps will help ensure that your
retirement is well-funded and enjoyable. How many of
these slip-ups are you currently committing? What is your
plan to rectify the situation? How are these decisions
impeding your retirement planning efforts?
“Wisdom and penetration are the fruit of experience,
not the lessons of retirement and leisure.
Great necessities call out great virtues.”
- Abigail Adams
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Retirement Planning for the Self-Employed
The Retirement
Obstacles Created by
Self-Employment
When it comes to self-employment, there are many
advantages. However, there are also some disadvantages.
With some self-discipline, many of these disadvantages can
be avoided.
Are any of these obstacles impeding your ability to
prepare for your retirement?
1.
Putting off saving for retirement. Most of the selfemployed realize that retirement planning is an issue. In
the early years, it’s common to struggle or believe that
the best investment is to reinvest in your business.
•
Saving in the early years is much more critical than later
on due to the power of compounding. Use a savings
calculator and see for yourself. Saving diligently from
age 22 to 30 results in more retirement money than
saving from 30-65.
•
If you save $300 per month for 10 years at 10.5%
interest, you’ll have approximately $63,000. If you then
stop saving and simply leave the money alone for the
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Retirement Planning for the Self-Employed
next 33 years (age 32-65), you’ll end up with over $2
million!
•
However, if you start saving $300 per month at age 32
and save for the next 33 years, you only end up with
roughly $1 million.
•
Those first 10 years are worth twice as much as the next
33! Think about that.
2.
Saving for retirement requires more discipline.
Perhaps the best part of corporate benefits is the
automation. You can fill out a simple form, and a portion
of your paycheck is sent off to your retirement
accounts before you can get your hands on it. Out of
sight, out of mind. Those that are self-employed lack
that advantage.
•
The self-employed are much more likely to have the
following mindset: “I’ll pay all my bills, have a tiny bit of
fun, then I’ll save the rest.” This hardly ever works. Your
expenses will tend to expand to match the amount of
money available.
•
The solution is to pay yourself first. This is a common
theme, but it’s especially important for the selfemployed.
•
Although it’s challenging, take a portion of every
paycheck and set it aside. Refuse to touch it for any
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Retirement Planning for the Self-Employed
reason. At the end of the month, send the money off to
your retirement fund.
3.
A lack of expert financial help. Those who are not selfemployed have access to their HR departments, who
are versed in explaining benefits. In many cases, the
mutual fund company that supports the 401(k)
program will also come out to give yearly presentations
and field questions. Some companies even provide free
access to financial planners for their employees.
•
If you’re on your own, you likely lack this process.
Fortunately, there are many great books on retirement
planning and investing. There are also many experts
available, although consulting them could get costly.
•
4.
With a little diligence, you can overcome this
disadvantage.
Inconsistent income levels make it challenging to
plan. When you have conventional employment, your
salary is set and isn’t likely to drop, unless you get fired.
Being self-employed, you probably have a lot less
consistency.
•
Because of the potentially large income swings when
you’re self-employed, it’s important to save whenever the
opportunity presents itself. If you’ve had a few
challenging years and then things suddenly turn around,
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Retirement Planning for the Self-Employed
most people want to spend some money and enjoy
themselves. Avoid this temptation.
•
Just remember that you’re saving for more than just
this year. You’re also saving for the last few years when
you couldn’t save much.
Although self-employment poses some challenges with
regards to retirement planning, there are some solutions.
It’s simply a matter of getting started ASAP, investing
regularly, getting the information you require, and saving
whenever you can.
“Financial literacy is an issue that should command
our attention because many Americans are not
adequately organizing finances for their education,
healthcare, and retirement.”
- Ron Lewis
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Retirement Planning for the Self-Employed
Advantages of Being
Self-Employed
Even though it can be challenging at times, there are also
many advantages to being self-employed when planning for
retirement. The key is to make full use of them when you
can.
Use these tips to your full advantage if you’re selfemployed:
1.
You can catch up much easier than most. Your income
inconsistency isn’t necessarily a bad thing. You can also
have really good years that can allow you to save a lot
more than others.
•
There is a better opportunity to greatly increase your
income. A bachelors-level chemist making $45,000 per
year is likely to be making a similar salary 10 years from
now, with only small annual increases.
•
Many self-employed individuals don’t have the same
limits. You could potentially grow your business and
make 10x or 100x more than that chemist.
•
With some luck and hard work, it isn’t difficult to retire
with a large nest egg.
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Retirement Planning for the Self-Employed
2.
You have many tax advantages. One of the best things
any business owner can do is to get expert advice
regarding business taxes. Buy a book or seek the advice
of a corporate accountant. If you think creatively, it’s
possible to write-off nearly anything even remotely tied
to your business. Ensure that you’re getting all the tax
deductions available to you.
•
It’s often said that a business owner making $50,000
can live like he makes $70,000.
These two advantages can make a huge difference in your
ability to prepare for retirement. Are you doing all you can
to reap the benefits?
“Many seniors understand that Social Security is
social insurance as opposed to a program where we put money
aside for our own retirement. But most elderly individuals think
they're getting their money back. So it isn't selfishness
as much as a misunderstanding.”
- Richard Lamm
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Retirement Planning for the Self-Employed
Conclusion
Being self-employed has both advantages and
disadvantages in retirement planning. Take the time to
ensure that you’re doing all you can to manage both. Life for
the self-employed tends to be busier and more hectic. It’s
easy to fall into the trap of putting off saving for retirement.
While it’s possible catch up, it’s easier to not get behind in
the first place.
Retirement planning is important for everyone, regardless of
your employment status. Most of these retirement planning
faux pas are common to all employment types. All of us are
bound to take some financial missteps. But hopefully, we
can avoid making them when it comes to retirement. Start
saving today, and maximize your retirement nest egg!
“Preparation for old age should begin not later than one's teens.
A life which is empty of purpose until 65 will not suddenly
become filled on retirement.”
- Dwight L. Moody
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