Self-Employed - How To Save For Retirement

A Traditional IRA or a ROTH IRA is a great investment toward your retirement but they do have one major restriction. This being, that you need to have earned income, meaning being employed, having a job outside the household and that you receive W-2 type withholdings from your pay.

This is how IRAs were first set up back in 1974 for people that worked and didn't have a retirement plan offered through their employment. This was then modified in 1981 to include everyone that worked and it didn't matter if you had a plan through your job or not.

Now the question is what happens if you are self-employed? Since IRAs can only be invested in from earned income how do you save or invest or plan for your retirement?

The easy answer is called a SEP IRA. This is a great vehicle for a sole proprietor type of business. It has greater flexibility than a Traditional or Roth IRA and a greater tax deduction as well.

Lets Explore while not getting to complicated.

A SEP IRA is easy to set up and minimal paper worked involved. The money that goes into the SEP IRA must come from the earnings of your business not other investments.

You can invest anywhere from 0% to 20% of your net income, for a maximum of $49,000 in one year into a SEP IRA. Net income meaning gross income minus business expenses. So if your net income were $100,000 you could invest $20,000 into your SEP IRA.

This investment is also 100% tax deductible for the year in which it was put in. Net Income over $245,000 does not account into the equation because your max investment for the year is capped at $49,000. This is a great advantage over Traditional or Roth IRAs.

Like a Traditional IRA you pay taxes on the income when you start to withdraw the money after you have reach the age of 59 ½. It will be taxed as ordinary income. Also if you are an incorporated business owner receiving a W-2 type check from the corporation then your percentage is 0 - 25%. All investments earnings on the account are taxed deferred, meaning only taxed as ordinary income when you reach the age to start withdrawing.

The great tax advantage on a SEP IRA is this:

It is 100% tax deductible against your income while you are working. And in most cases when you are working, you are in a higher tax bracket, so that when you retire and start to receive a monthly income from the SEP IRA, you will most likely be in a lower tax bracket thus paying less tax than when you were working.

So in theory -

If you only had your business for ten years, and put in the maximum amount of $49,000 each of those years, then in ten years you would have $500,000 in your account and that is before interest earnings have been calculated into it. That means you would have over $300,000 more money in your retirement savings in ten years than you would have had if you worked in a regular job for 40 years and invested at today's maximum investment rate of aprox. $5,000 per year in a Traditional or Roth IRA.

That is astonishing!

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