Many Americans tend to live for just today. While “Carpe Diem” sounds good in theory, this ethos can interfere with your quality of life in the long run, after years of spending with reckless abandon catch up with you. And too many Americans have NO retirement savings nest egg whatsoever.
This is a troubling fact, considering social security will only cover an estimated 40 percent of one’s pre-retirement income. Even if you have paid off your mortgage and anticipate significant savings with the elimination of your daily commute, your cost of living will continue. Utilities, home maintenance costs, property taxes, healthcare, vacation, and entertainment costs will persist. Most people need at least 80 percent of their pre-retirement income to live comfortably, so where will the other 40 percent come from?
Maybe you work for yourself, or your employer simply doesn’t offer a plan. Either way, you have options. Now is as good a time as any to start thinking seriously about individual retirement savings. Retirement plans for individuals include the solo 401(k), traditional IRA, SEP IRA, and Roth IRA.
What is a Solo 401(k)?
The Solo 401(k) operates like a typical 401(k) but is open to owner-only “businesses.” The business establishing the Solo 401(k) can be structured as a sole proprietorship, partnership, or corporation.
Who can open a Solo 401(k)?
One-participant plans are designed for “businesses” with no other employees or with employees who are not eligible to participate in an employer-sponsored program, such as those who work less than 1,000 hours per year or who are younger than 21. To qualify for a Solo 401(k), you must have earned some type of income from self-employment. You may work full-time for an employer and have a side hustle. Any income from your side business would then be eligible to enter into a solo 401(k) plan.
What are the benefits of a Solo 401(k)?
One of the main benefits of a Solo 401(k) is the amount you contribute to the plan. Consider this comparison with a Traditional Individual Retirement Account (IRA): In 2019, individuals could only contribute up to $6,000 into an IRA, while a Solo 401(k) allowed contributions up to $56,000. Individuals over the age of 50 were permitted $1,000 in catch-up contributions to an IRA. Solo 401(k) plans authorized an additional $6,000.
Other Solo 401(k) advantages include:
- Pre-tax salary contributions that will reduce your taxable income.
- Ability to maximize savings with additional after-tax Roth contributions.
- Write off any plan contributions and expenses as a business tax deduction.
- Enjoy pre-tax growth on your investments while in the plan.
- Retain the option to borrow a loan from your retirement savings if necessary.
Since there are no employees, plan administration is exceptionally low-maintenance. You don’t have to worry about nondiscrimination tests or annual reports with the IRS unless or until your plan reaches $250,000 in assets.
What is a Traditional IRA?
Unlike a 401(k) plan that must be opened by an employer, anyone with taxable income (or who has a spouse with earned income) can open an IRA. A Traditional IRA is a long-term retirement savings vehicle that allows you to defer taxes on the earnings and growth of your savings until you reach at least 59.5 years of age. If you try to dip in early, you will be subject to a 10 percent early distribution penalty payable to the IRS. You will also have to pay taxes on the amount of the withdrawal at your current income tax rate. Traditional IRA distributions are not required until after 70.5 years of age.
Who can open a Traditional IRA?
Nearly anyone can contribute to a traditional IRA. You need only receive taxable income. Before 2020, you had to be under 70.5 years of age to contribute to a traditional IRA. However, now there is no age limit on making regular contributions to Traditional IRAs.
What are the benefits of a Traditional IRA?
Traditional IRA plans allow savers to deduct contributions from their taxable income. No taxes are paid on interest or gains, while the savings continue to grow year after year. Taxes are due at the time of withdrawal, at your retirement income rate – which should be substantially less in retirement than it is now while you are working.
A traditional IRA is particularly beneficial in the following ways:
- An IRA is an investment account, so instead of earning a meager 0.5 – 2.5 percent annual interest in a high-yield savings account, your contributions can be invested in mutual funds, bonds, or index funds to achieve higher returns.
- Traditional IRA accounts are tax shelters, so gains, dividends, and interest are all non-taxable. Your money can grow considerably over the years. IRAs are a great way to save for the future, even if your employer does not offer a matched savings plan.
- An IRA can be opened in addition to an existing 401(k) to maximize your savings.
In 2020, individuals under 50 can contribute up to $6,000. Catch-up contributions for older investors of $1,000 are allowed. In addition to depositing annual contributions, IRA savers can fund their IRA account with benefits rolled over from a former employer’s retirement plan or another IRA.
What is a SEP IRA?
A Simplified Employee Pension (SEP IRA) is a variation on a traditional IRA that is especially well-suited to sole proprietors and business owners looking to cover one or more employees. Employees do not contribute to their own accounts. Instead, employers make tax-deductible contributions on behalf of all eligible employees.
Who can open a SEP IRA?
Any business owner with one or more employees can open a SEP IRA. Anyone with freelance income can contribute. To be eligible, employees must be at least 21 years old and have worked for the company in three of the last five years, receiving at least $600 in compensation during the year.
What are the benefits of a SEP IRA?
SEP IRA contribution limits are much higher than a Traditional IRA – more like a Solo 401(k). Individuals can contribute up to 25 percent of their net earnings (annual profits minus half of one’s self-employment taxes), up to $57,000 in 2020.
Other advantages of the SEP IRA include:
- Administrative costs are relatively low.
- There is no annual funding requirement.
- Employers have control over how much to contribute annually.
- The plan offers flexibility to vary contributions, skipping years, or adding end-of-year lump sums.
The SEP IRA is also renowned as the most manageable plan for an individual to establish and operate.
What is a Roth IRA?
A Roth IRA is a retirement savings vehicle that allows you to withdraw your savings and distributions tax-free. Unlike a Traditional IRA, contributions to your retirement plan are not tax-deductible at the time of deposit, but the earnings on your Roth contributions still grow tax-free. If you play by the rules, you can take out the money at the age of retirement without paying federal taxes on it.
A “qualified” withdrawal occurs under any of these circumstances:
- At least five years after you have opened your Roth IRA,
- When you are 59.5 or older,
- Due to a permanent disability,
- By a beneficiary of your estate after your death, or
- To buy/rebuild your first home.
But remember, there is still a 10% IRS penalty if you withdraw funds before age 59.5.
Who can open a Roth IRA?
You can contribute to a Roth IRA whether you are married, filing separately, single, or filing as head of the household – as long as your modified adjusted gross income is less than $139,000. If you are married and filing jointly, you can contribute to a Roth IRA if your income is less than $206,000. To avoid reductions in contribution amounts, you will need to make less than $124,000 (separate) or $196,000 (joint).
What are the benefits of a Roth IRA?
Roth IRAs offer certain freedoms that most other retirement savings vehicles do not. For instance:
- There is no minimum distribution requirement, so you are not forced to take distributions from your account at a certain age. If you wish, you can even leave IRA money to your heirs.
- There is also no age limit for making contributions, making it an excellent option for older folks who continue to work into their golden years.
- Since you have already paid taxes on your contributions, you can withdraw them without tax or penalty.
- Tax-free distributions are allowed once you reach age 59.5 and have had your IRA for at least five years.
Individuals can also make a Roth IRA contribution for a non-working spouse who has no earned income.
Let Ubiquity Help You Decide Which Individual Retirement Plan is Right for You
With so many options for individual retirement plans, there is much to consider when settling on the best choice for you. Let us help guide you on the path that will yield the greatest benefits for your future. Contact Ubiquity and take those first steps today!