If you're self-employed, you probably spend your days focusing on your business. How can you attract new customers and keep your current clients? Do your products or services still meet the needs of your market? Is anyone falling behind on payments?
But regardless of the daily business issues, you also need to think about the future and start saving for retirement. With the start of the New Year, now is an ideal time to set up an account that can provide you with immediate tax benefits as you build a nest egg for the future.
Three common options for self-employed professionals or business owners are: traditional (non-Roth) Individual Retirement Accounts (IRAs), defined contribution (DC) plans like 401(k)s (again, non-Roth) and defined benefit (DB) plans like traditional corporate pensions. While each type of plan has its own characteristics, they all allow you to start saving for retirement, while deducting qualified contributions from your annual income tax return.
So, if you are in the 33 percent tax bracket and contribute $10,000 to a 401(k) in 2015, that $10,000 would be subtracted from your gross income, reducing your taxes by $3,300. Those contributions would then grow tax-free through the years until you begin making withdrawals in retirement. At that time, you would have to pay the taxes, but your income would probably be lower than it is today, so you likely would be taxed at a lower rate.
Of course, those same tax-deferred benefits also apply if you are an employee of a company with a 401(k) or other DC plan. So, even if you are not self- employed, one of the best steps you can take for your future is to start contributing to your plan or increase your level of contributions in 2015.
In an effort to encourage Americans to save for retirement, the government has designed several types of IRAs. While some are meant to supplement a DC or DB plan offered by your employer, the Simplified Employee Pension (SEP) and the Savings Incentive Match Plan for Employees (SIMPLE) plans are designed for the self- employed. Either will allow you to contribute a larger amount of your earnings than a traditional IRA.
One of the most popular plans is a SEP or SEP-IRA, which allows you to contribute up to 20 percent of the net earnings from your business up to a specified maximum amount. In 2015, the maximum contribution is $53,000. A major benefit of a SEP is its flexibility. If your earnings go up or down in the coming year, you can adjust your contributions accordingly. The SEP can also be an excellent plan for sales professionals with an irregular flow of income, as a portion of each commission check can be contributed to the SEP.
For small to mid-size businesses or professional firms, a SIMPLE IRA offers owners an option to make contributions as both employee and employer. If you are at least age 50, you can also make “catch-up” contributions, so that your retirement savings grow more quickly.
Another option to consider is starting a 401(k) Keogh Profit Sharing Plan. Although many people think these plans are only available to corporations, they can also be opened by a sole proprietor. However, these types of plans are complex to implement and may be more expensive to operate than a SEP-IRA, because they require more tax-related paperwork (and your accountant's time).
Nonetheless, 401(k) Keogh Profit Sharing Plans allow you to contribute up to 20 percent of self-employed net earnings (not to exceed $265,000) that, combined with an individual deferral of up to $18,000, can bring you to a maximum of $53,000 in 2015. If age 50 or older, an additional $6,000 can be contributed.
Finally, self-employed owners or professionals can implement a solo defined benefit plan that will provide you with a certain level of monthly income in retirement. There is no upper limit to the amount you can contribute, and if you plan to work for several decades, the total assets in your DB plan can be quite substantial. However, there is a maximum annual amount you can receive in retirement. That limit is $210,000 in 2015.
There are many options for self-employed individuals, you should talk with a tax or benefits plan professional to see what makes sense for your individual situation. Regardless of the plan you choose, you should make 2015 the year to get serious about saving for your retirement.\
Andrew Menachem, CIMA, is a Wealth Advisor at the Menachem Wealth Management Group at Morgan Stanley in Aventura. Views expressed are those of the author, not necessarily Morgan Stanley, and are not a solicitation to buy or sell any security. The strategies and/or investments referenced may not be suitable for all investors. Follow Menachem on Twitter @AMenachemMS