As an independent contractor who makes about $145,000 per year, what are my best options to save for retirement?
I’m an independent contractor and make about $145,000 per year. My wife’s income is much higher and she maximizes contributions to both her 403(b) and 457(b) plans. What are my best options to save for retirement? Should I consider a SEP IRA or a 401(k)?
Congratulations on saving for retirement. The best way to save for retirement is to keep more of what you make. This is done by reducing your current taxes and allowing your money to grow tax deferred.
In general a Solo 401 (k) plan can provide better tax savings because you can contribute both as an employee and an employer which allows you to contribute more money to the plan. Additionally, if you are over the age of 50 there are catch up provisions that can allow you to contribute even more.
The SEP- IRA is a little easier to administer and at $145,000 since you can not contribute more than 25% of your income, you will fall under the maximum $55,000 limit for a SEP-IRA.
Basically either option would work for you at this income level. The important things to consider would be the ability to earn significantly more so that a solo 401k makes more sense and if not than how whether the slightly easier administration on the SEP-IRA makes sense.
If your goal is to put the absolute most possible into tax-advantaged retirement accounts each year then a solo - 401(k) will be your best option. A SEP IRA will be your second best option and depending on a number of other circumstances should be considered.
Two more things to consider:
1. If you all do not have additional pre-tax/traditional IRAs you and your wife should make non-deductible maximum contributions to IRAs, and then convert them to Roth IRAs. Taking a few additional steps to max out Roth IRAs.
2. Also a unique idea you might consider woudl be making maximum contributions to your SEP IRA and converting it to a Roth each year. There by getting to contribute way more than the standard $5,500 per person Roth limits.
Being an independent contractor gives you lots of options to select a retirement savings. To start, it really depends on how much you want to stash away. Both SEP IRA & 401k offer a large amount of savings for your retirement, but 401k may offer more because you can do the age catch-up, which is $6k additional contribution once you turn 50. SEP IRA, on the other hand, does not allow the age catch-up.
Besides the contribution limit, you may also consider other factors when selecting an appropriate retirement plan for your business, such as 1) Will you hire employees in the near future? 2) How would you make contribution on their behalf? Do you prefer make it for them (SEP is funded solely by the employer), or do you prefer employees make some contributions on their own (401k is a partnership: employees make the deferrals, and the employer makes the matching and offers additional savings)? 3) What kind of cost are you looking for? SEP is relatively inexpensive to set up in comparison to the 401k. 4) Do you need a strong creditor protection? Because the 401k is governed by the ERISA law, it offers a stronger creditor protection than SEP.
Thus, when deciding a retirement plan for one’s business, tax and savings are not the only factors to consider. You must have a plan that can grow with your needs. In order to do so, a face-time with a CFP® who intimately knows retirement plans and with a background of tax knowledge is highly recommended. Best!
Kudos to you for wanting to maximize your retirement savings. As a Schedule C business owner, you have many more options than your wife (whom I assume is working in the public sector given the 403(b) and 457 plans.
Since you do not have employees, I strongly recommend you look into opening a solo 401(k). These are also called individual or I401k's; they are one in the same. A solo 401k plan is pretty much exactly what it sounds like: a 401k designed for a business owner with no employees.
For contribution limits, think of yourself as two people: an employer and an employee. As both, you are able to contribute $18,500/year ($24,500 if over 50) as an employee PLUS an additional profit-sharing contribution of 25% of your Schedule C net income. Although it's not applicable in your case, it's good to know that the limit on compensation that can be used to factor your contribution is $275,000. We use Schwab as custodian for our client assets and they do not charge additional fees for solo 401k's; they are treated just like any other account.
Contributions reduce your taxable income dollar-for-dollar which can be very beneficial in high-income earning years while you and your wife are dual earners.
There's no reason for you to create a SEP unless you hire employees. The solo 401k offers the same benefits of a SEP but with higher contribution limits.
A quick point to make - solo 401k's MUST be created prior to December 31st of the tax year you wish to contribute. It only needs to be created; you are able to fund for prior year up to the tax-filing deadline (including extensions). Your CPA is responsible for coding the year of the contribution. The amount will be noted on line 28 of your 1040 as an adjustment to gross income.
I hope this helps. Feel free to call with any questions.
Aaron Szager, CFP(R)
We would love to be able to help you! However, to get started on the right foot, we have many ?’s to ask you first. We work very much like a doctor would. Keep in mind you just don’t walk into the Doc’s office and immediately get a prescription.
In fact we always say that prescription without diagnosis is malpractice.
So let’s get started…..
We have many questions:
- What do you do for a living?
- Do you have any old accts from prior work?
- Do you have children?
- Have you done any estate planning? if so what?
- So you have your entitiy pay you thru an LLC or S-corp?
- What is your risk tolerance ?
- What state would you like to retire in?
- Do you own any life insurance? if so what kind?
There is so much more to go over here.... its not just a simple answer. We can help, give us a ring.
Brett M. Sause, LUTCF®, LTCP®, CLTC®, RFC®, LACP®, FSCP®
Principal & CEO