Retirement Planning for the Self-Employed

I had a recent visit from a new client of ours, let’s call them John and Sue.  They are both 46, married for 19 years, a couple of kids, who are seeking advice about some challenges they may face leaving corporate life to open their own business in Mashpee. 

I explained to them that I find being my own boss very rewarding, in so many ways. I get to do something I love every single day. Similar to John and Sue’s situation, many years ago after working for large corporations, Jill and I sat down and decided it was time for a change. I’ve always had an entrepreneurial spirit going back to my teenage years when I owned my own landscape business, had paper-routes, etc., for whatever reason, this isn’t a trait that’s often recognized or rewarded within large companies. But I knew that there was a strong need for financial education and simple straight-forward advice for those seeking sound retirement systems, and I knew it was the right move for Jill and me.

Years back, as a new business owner, I grappled with the same issues that just about every other self-employed person faces – keeping the business afloat, especially in the early days, while also keeping an eye on the day of retirement. 

I discussed with John and Sue that over the years I have found that one of the biggest hurdles entrepreneurs face is not planning adequately for their retirement. Get this; nearly 15 million Americans are self-employed, according to the Pew Research Center. That number is expected to only grow in the coming years. I find that while the spirit of the entrepreneur may inspire many folks, and self-employment can be incredibly rewarding, being your own boss also brings challenges, such as planning for your retirement.

But this challenge is not insurmountable! If you are self-employed or thinking of becoming self-employed, there are practical reasons here and now to make establishing your retirement plan a priority, both for your benefit and for the benefit of your business. 

So, with our time together this week, let’s look to understand some options that are available to John and Sue, and our self-employed Cutter Family Finance faithful.

Well, no one is going to do it for you, and it’s something you need. And funding a retirement account can also be deducted as part of your business expenses, helping to reduce taxable income. Depending on the company retirement plan you adopt, you may be able to contribute more to your plan annually as the business owner than you could as a plan participant. 

First, let’s look at the Solo 401(k). Pretty much exactly what it sounds like: an individual 401(k) designed for a business owner with no employees. In fact, IRS rules say you can’t contribute to a solo 401(k) if you have employees, though you can use the plan to cover both you and your spouse.

Unlike a conventional 401(k), a Solo 401(k) allows you and your spouse to contribute both as an employee through an elective deferral and as business owners, through non-elective contributions. You see, that is because as the business owner you are technically both the employer andthe employee.  The result is you potentially end up with a higher contribution limit than you can achieve with some other tax-advantaged plans. Total contributions to a participant’s Solo 401(k) account can be up to $56,000, or $62,000 for those age 50 or older.  Conventional 401(k)’s have an annual contribution limit of $19,000 and $25,000 for 50 or older.

Folks, this creates a significant opportunity for the self-employed to stash away almost 2.5 times what a conventional 401(k) allows.

While Solo 401(k) plans have the same rules and requirements as their corporate counterparts, including a stiff 10% penalty for early withdrawal before age 59 ½, they also can enjoy the same tax advantages. Contributions can be made pre-tax, and grow tax-deferred.  But remember, all qualified distributions are taxed as ordinary income. 

Another great option is a Simplified Employee Pension (SEP) IRA. A SEP IRA is another type of a basic retirement account, much like a traditional IRA. SEP IRA contributions are tax-deductible, and investments grow tax-deferred until retirement, when distributions are taxed as ordinary income.

SEP IRAs allow you to contribute up to 25% of your net business earnings, calculated by subtracting half of your self-employment taxes from your annual profit, up to a maximum of $56,000 in 2019. SEP IRA plans offer flexible contribution schedules and incur no yearly funding requirement. 

The biggest consideration for a SEP IRA is that if you have employees whom the IRS considers eligible participants in your plan, you must contribute on their behalf, and those contributions must be an equal percentage of compensation to your own. Eligible participants are employees who are 21 or older, have worked for you for three of the past five years and have earned at least $600 from you in the past year.

Because of that rule requiring equal contributions as a percentage of compensation, a SEP IRA is generally best for self-employed people or small-business owners with few or no employees.

Lastly, let’s discuss Health Savings Accounts (HSA).  While an HSA is not a retirement savings vehicle per se, it does offer some appealing benefits well worth mentioning. 

This is because according to the recent Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 in 2019 may need approximately $285,000 saved (after tax) to cover health careexpenses in retirement. Of course, the amount you’ll need willdepend on when and where you retire, how healthy you are, and how long you live

HSAs are funded with pre-tax contributions and the money in them grows tax-deferred, just as it would with a Solo 401(k) and a SEP-IRA. The funds can be used as needed for any out-of-pocket medical expenses – paying doctor’s bills, eyeglasses and contacts, copays, pharmacy, durable medical equipment and more. 

The funds in your HSA – and their earnings – roll over from year to year. Once you reach age 65, you can withdraw HSA funds for any reason. If it’s for qualified medical purposes, it’s tax-free. If not, it will be taxed as ordinary income.

Remember folks, even if you are just starting out like John and Sue, you must pay yourself first, even if it’s only a few dollars a week! In this situation, good behavior can result in significant financial results.

Administration and paperwork will vary with each of these plans. After discussing John and Sue’s goals and needs, and especially their appetite for risk, they decided to implement a Solo 401(k). Within their newly formed Solo 401(k) we designed and deployed an investment strategy that uses downside risk mitigation triggers to help reduce volatility while potentially capturing the upside . . . only when momentum is on their side.  John and Sue are now positioned for financial success.

Whether you’re self-employed or enjoying the many benefits of working for someone else, there’s no excuse for not taking action and building out your sound retirement system.  

Folks . . . what’s your system?

Be vigilant and stay alert, because you deserve more.  Have a great week!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at

Cutter Financial Group LLC (“Cutter Financial”) is a SEC Registered Investment Advisor.

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