While preparing for the future is important for anyone, as an owner-operator, saving for your retirement – as well as other important financial goals – is especially critical. As a self-employed business owner, it’s important to take action now to ensure you have enough money to retire at a comfortable financial level.
Knowing Your Needs
While saving is a challenge, mastering the art of controlling spending will help you ensure you have enough money post-retirement to maintain your lifestyle. The earlier you begin to save, the better off you’ll be, since any money you invest will compound and grow over a longer period of time. Finding ways to live comfortably on less will also make it easier to make your savings last longer in your retirement years.
How much should you save? Figure out how much it costs you to live by adding up the cost of housing, food, transportation, travel, entertainment, and any other monthly expenses you may have. Account for a yearly inflation rate of approximately 3 percent, and try to estimate any increases or decreases, such as medical or housing costs. Next, use an online calculator to estimate your life expectancy. Try more than one, using factors such as medical conditions to determine how many years of retirement to plan for.
Savings and Social Security
Although many Americans rely on their Social Security check each month, don’t count on it being enough to fully support you in retirement. According to the U.S. Department of Labor, Social Security provides approximately 40 percent of the income the average person received prior to retirement. Although estimates vary on how much you’ll need to live on depending on your post-retirement expenses, financial experts say you’ll likely need 75 to 80 percent of your pre-retirement income.
For example, if you’re unmarried and your income is $100,000 annually before taxes, you may choose a target of 75 percent. If you anticipate approximately $26,000 per year in Social Security benefits, then you’ll need to replace $49,000 per year with income from other sources such as dividends from investments, retirement funds, or income from a part-time job.
Remember to carefully weigh your options when choosing whether or not to begin receiving Social Security benefits early. You have the option to begin early at age 62, at full retirement age (age 66 or 67, depending on when you were born), or later. If you claim early, your benefit will be reduced to 75 percent of your full monthly benefit and will remain at that reduced benefit for the rest of your life. However, if you wait to take Social Security until full retirement age, you’ll need to live longer to make up for the payments you could have been receiving.
Choosing a Retirement Plan
A qualified retirement account makes sense because you don’t pay taxes on the earnings until you begin withdrawing the funds. Since you won’t be taking out the money until you retire, you should be in a lower tax bracket then and therefore paying less in taxes than you would if you paid the taxes now. Many retirement plans also allow you to deduct your contributions to the plan from your income. So, if you made $60,000 and contributed $5,000 to your plan, you would report $55,000 on your income tax return.
What are the options? For owner-operators, Individual Retirement Accounts are a popular choice.
Traditional IRA. For those without an employer-sponsored account, a traditional individual retirement account allows you to contribute $6,000 per year if you’re under 50 and up to $7,000 per year for those 50 and older. Investments grow tax deferred until the investor withdraws funds during retirement.
Roth IRA. The biggest difference between a Roth and a traditional individual retirement account is how they are taxed. Roth IRAs are not pre-taxed, so the contributions are not tax-deductible. However once you begin to withdraw money, those funds are tax free. Also, the Roth IRA has a limit on how much yearly income you can have while contributing – if you will make more than $144,000 (single) in 2022 or $214,000 as a married couple filing jointly, you can’t contribute to a Roth IRA.
The attractiveness of a Roth IRA is that you can withdraw funds tax-free once you are retired. However, if earlier tax advantages are more suitable for you, a 401(k) might be a better option. These accounts allow you to contribute prior to income tax deduction and often have much higher contribution limits than Roth IRAs. For individuals wishing to take advantage of higher limits, in 2021 the Roth 401(k) limit was $19,500 for those under 50 and $26,000 for individuals 50 and over, compared to $6,000 and $7,000 for the Roth IRA. Additionally, if you are a company employee, 401(k) accounts allow employers to make matching contributions. The downside to a 401(k) is limited flexibility, so if you want more control over your funds, an IRA might be a better option.
No matter what path you take to securing your future, you needn’t go at it alone. You can find basic tools online for free, and online brokers can assist you in setting up accounts. For more in-depth assistance, talk to your accountant about retirement planning. If you’re starting from scratch on savings and investments, consider hiring a financial planner to walk you through the process. It could be the best investment you’ll ever make.