Written by: Jessica Larson, SolopreneurJournal.com
When it comes to saving for retirement, you’ve got more options than you may think. When you’re an entrepreneur, though, it can seem overwhelming.
You’ve already got to stay on top of many of the things that an employer traditionally sets up for you, such as paying taxes and managing health care. That’s not to mention the things that just go along with running a business, such as keeping ledgers, staying on top of payments from clients and to creditors, asset depreciation, marketing, utility costs…the list goes on.
Adding retirement to that list is necessary, but with all the options that are available, it can feel like yet another distraction. Here are a few tips on where to start exploring those alternatives and a list of factors to consider as you look into each one.
Real Estate Investments
When looking for a source of income during retirement, it can be tempting to check out your home equity, especially if your house is paid off. Empty nesters often find themselves with too much living space, and entrepreneurs who want to focus on their business may not have the time or inclination to take care of a larger home.
The option to sell and move into something smaller—and cheaper—can sound appealing. You can transfer any cash you earn into a retirement account to earn interest, and you’ll likely save money on things like property taxes and utilities, too.
That said, whether you’re better off relying on your home as a source of income for retirement or not is a matter that’s open for debate. There may be better options, but depending on your situation, it’s something to consider.
Before you start saving for retirement, take a look at your debt load. If it’s too big, then it’s worth paying some of it down before you dedicate every extra penny to building your retirement accounts.
Here’s why: although you’ll be building interest in any existing retirement accounts, you’ll also be paying interest on debts you owe. If those are loans where you’re paying a lot of interest, such as high-APR credit cards, then you may be actually losing money overall.
Of course, the tax advantages of opening a retirement account should be factored in as well. Also, you may need to do some math to find out which approach saves you the most: paying off debt, building retirement, or some combination of the two.
As an entrepreneur, you won’t have access to an employer’s workplace 401(k) plan (unless you set one up for yourself), so you’ll have to come up with an alternative. Fortunately, you have no shortage of options, starting with an IRA account.
There’s actually more than one kind of IRA, and the one you choose depends in part on how and when you prefer to pay your taxes.
With a traditional IRA, you take tax deductions on the money you contribute and pay the IRS when you withdraw the money in retirement. There are contribution limits. In 2021, you can put $6,000 a year into your IRA, or $1,000 more than that if you’re 50 years old or above.
A Roth IRA works the opposite way. You don’t get to take tax deductions when you contribute, as you do with a traditional IRA, but the tax pain comes now, not later. You won’t have to pay anything to Uncle Sam when you withdraw the money for retirement. As a bonus, if you need the money, you can pull out any contributions you’ve made without penalty before you retire. However, keep in mind that this will reduce the amount of principal on which you can draw interest.
Another option is a solo 401(k). You may not have realized that you can still set up a 401(k) as a self-employed owner. The main difference is that you make contributions on both sides. From the employee side, you can put as much as $58,000 into your account, or more if you’re 50 or above; from the employer side, you can add up to 25% of your net entrepreneurial income.
As with a Roth IRA, you pay your taxes when you take withdrawals in retirement, but you can’t do so without penalty until you’re 59½.
Whole Life Insurance
No one wants to think about end-of-life decisions, but a whole life insurance policy can provide you with some positive incentive because it can be a vehicle for retirement savings too. If you choose this option, though, it’s best to sign up before you’re 45, so your money will have a chance to build interest and you won’t be disqualified by health issues that can crop up later in life.
Under a whole life plan, you can put your money in a place where it can grow at a set interest rate, tax-free. Then, if you choose to, or have an emergency that requires it, you can tap its cash value via a loan. On the positive side, you won’t have to pay the IRS for taking out the money, but the downside is that it will eat into the value of your heirs’ benefits later on.
A whole life insurance policy isn’t your only option when looking to ensure your family is secure, whether it involves making medical decisions, stipulating power of attorney, or overseeing your estate. An estate planning checklist can help you cover every eventuality.
Building your financial resources to plan for your retirement also involves building good credit.
When you’re self-employed, establishing good credit is even more important because without a traditional job, you’ll need more evidence of creditworthiness in order to receive approval for things like a mortgage or car loan. The same principle applies when you retire.
That’s why it’s important to start building credit now, especially if your credit has been damaged and you need to start over. One possible way to do so is through a secured credit card. In exchange for depositing a few hundred dollars in a linked account, you get access to a line of credit and a chance to build your positive credit history by making on-time monthly payments. The cash you deposit is only accessed if you don’t pay.
These are just some of the options you can consider as a self-employed person looking to plan for retirement. Others may be available, as well. The important thing is to do as much research as you can, and take your personal situation into account before deciding which one, or combination, is right for you.