Smart Money Podcast: Saving for Retirement When You’re Self-Employed: SEP IRAs, SIMPLE IRAs and Other Plans

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Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:

Learn retirement savings strategies tailored for self-employed individuals to secure a financially stable future.

How can self-employed individuals effectively save for retirement? What tailored retirement plans should freelancers and small business owners consider? NerdWallet’s Sean Pyles and Elizabeth Ayoola discuss the unique challenges of retirement savings for the self-employed and the different retirement plans available to help you understand how to secure your financial future while running your own business. They begin with a discussion of the hurdles of inconsistent income and strategies to manage expenses, with tips and tricks on proactive contribution, the transformative power of compounding interest, and paying oneself a consistent salary.

Ayesha Selden, a stock broker, certified financial planner, real estate investor, and art collector, joins Elizabeth to discuss the intricacies of various retirement accounts for the self-employed. They delve into the benefits of using qualified plans like solo 401(k)s, SEP IRAs, and SIMPLE IRAs, aligning retirement plans with business models, and the strategy of funding retirement through the sale of a business. They also highlight the importance of diversification to mitigate risks, building strong savings habits early on, and the potential of setting a consistent salary for financial stability.

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Episode transcript

This transcript was generated from podcast audio by an AI tool.

Some might argue that self-employment isn’t that different from any other type of employment. You still have to work. You still make money. Someday you still hope to retire from that job. But that’s where you’ll find definite dissimilarities: retirement. It’s not as simple as choosing your 401k options with an employer.

If I can get to 10%, a double-digit percentage of my pay, of my gross pay, my pre-tax pay, I’m in the right ballpark. If you’re self-employed, then the onus is on you, of course, to put in everything into your own personal retirement plan.

Welcome to NerdWallet’s Smart Money Podcast. I’m Sean Pyles.

And I’m Elizabeth Ayoola.

Today, we bring you episode three of our nerdy deep dive into self-employment. Today, we’re focusing on the years that come after working for yourself, the years you hope to retire.

I hope those years are closer than farther away, Sean, but… Yeah.

When you work for someone else, your retirement options are mostly decided for you. Usually, you have a pension or a 401k or a 403b, but the choices are really limited to whatever your employer offers. But that’s not the case if you’re self-employed.

No. In fact, you have a lot of choices to make, and today we’re going to ask: do you incorporate so you can get one set of options, or do you not and get another set of options, and how much can you set aside for each? That’s what we’re going to explore to help any of you who are thinking about going to work for yourself make sure you’re also making the right decisions for your post-working life.

I think that’s probably the most important aspect of all of this, making sure that you’re contributing to retirement in some way, even though you’re self-employed. It’s so easy to let your retirement savings slide or just like to procrastinate, especially when your early years of self-employment aren’t very profitable. You want to squeeze all you can out of the paycheck, and it just feels like retirement savings can wait. But if you don’t want to have to wait until way beyond the retirement age to pack up your work desk, it’s something worth thinking about and starting.

Yeah. It’s never a good idea to wait on retirement savings, so we’re going to talk through how to do that, even on a limited business budget. We’ll also look at how selling your business down the line could be an extra financial help in retirement. All right. Well, we want to hear what you think, too, listeners. To share your ideas, experiences, and questions around self-employment with us, leave us a voicemail or text the Nerd hotline at 901-730-6373. That’s 901-730-NERD. Or email a voice memo to [email protected].

So, Elizabeth, who is helping us out today?

We have Ayesha Selden. She is a stockbroker, a certified financial planner, a real estate investor, and an art collector. Ayesha has been in the finance world since 2000, so that means she has abundant knowledge and expertise to share with us.

All right. Well, stay with us. We’re back in a moment.

Hi. Thank you, Elizabeth. I’m glad to be here.

From my knowledge, Ayesha, you happen to be self-employed and also in formal employment. Is that correct, or am I wrong?

So I work for a firm that is a wealth management firm, and we offer our advisors two different tracks. One, you can be a W-2 employee, which I was in our firm for the first 14 years of my career. Almost 10 years ago, I pivoted to our franchise side, which on that side we’re 1099 independent contractors. So, yes, I am self-employed. I hire my own staff. I pay my own rent and other expenses and health insurance and self-employment tax and all that good stuff.

So, that said, I want to ask you, how did you get started with retirement savings as a self-employed person?

A part of it is just what I do professionally. I happened to grow up as a wealth manager. I’m a certified financial planner and have been so for… I became a CFP in 2003. I became a securities registered representative back in 2000, almost 24 years ago. It was kind of ingrained in me. So me being a person that tries to practice what I preach, working with clients to help them with retirement savings, it made sense for me to learn those practices and habits really early on. Obviously, the earlier you can start when we start thinking about things like compounding interest and how that works, time is one of your biggest advantages. So I got started planning for retirement when I was in my very early 20s.

When I speak to self-employed people, a lot of people are so busy trying to make money that they haven’t stopped to think about retirement. They’re like, “I’ll do that when I have more money.” What are some main hurdles that self-employed people face when it comes to saving for retirement?

One of the things that makes it just a little bit more challenging for folks who are self-employed is really just the consistency of pay. If you have a W-2 job, for example, if you’re an employee, usually, your pay is fairly predictable. You’ll get typically the exact same amount outside of bonuses, or if you’re an hourly employee, your pay may vary slightly. But for the most part W-2 employees tend to get very consistent steady income. What we find for independent contractors or self-employed folks, it’s usually based on sales revenue. You may have a great month or a great quarter or a great first half of the year, and the back half may look totally different.

So that becomes a little bit more challenging for business owners to figure out, “How do I manage my expenses considering the fact that my income is so inconsistent?” We try to give them different ideas and techniques on how to maybe put them on payroll, put themselves on payroll, and then they take a consistent income so we can show them how they can manage not only their expenses but also how do they consistently save for goals like retirement or maybe education planning for their children or building an emergency reserve.

This is interesting because I was chatting to some women I met over the weekend and they happened to be newly self-employed. They were talking about how they’ve kind of put off their retirement savings for similar reasons that you mentioned, not having consistent income or just trying to focus on other financial goals. Do you see that as a hurdle for some people as well, maybe thinking saving for retirement is too difficult or they need more than they have, things like that?

It’s a daunting thing, particularly if someone’s maybe in their 30s or 40s and they’re trying to get this business off the ground. Normally, the business and its expenses take precedence. If you have employees, for example, you can’t not pay your employees because you want to put money into your SEP IRA, or 401k. Oftentimes, what we find is that if clients are so focused on the long-term goals like retirement planning or college savings that they forget about making sure that they have emergency money set aside. For example, if you put together a very elaborate retirement plan but you have no emergency savings and then something happens because that’s life… Life be lifing, as we say. So if you have no emergency reserves but you have yet a very elaborate retirement plan, what you’re going to have to do is dip into that retirement plan, and just starting habits like that can be quite challenging because once you’re in the habit of busting into your 401k or SEP IRA for emergencies, it becomes a long-term habit.

I also want to ask you, in terms of retirement savings, for people who are not very conversant with how much they should save, and I know that varies from person to person, what is a ballpark percentage or figure you would give? I know at NerdWallet we say you should try to save maybe around 10 to 15% of your pre-tax income.

Yep. I’m a huge fan of just getting to that double-digit percentage. If I can get to 10%, a double-digit percentage of my pay, of my gross pay, my pre-tax pay, I’m in the right ballpark. If you’re self-employed, then the onus is on you, of course, to put in everything into your own personal retirement plan. I understand that being on the self-employed side you don’t get some of the health and welfare benefits like a 401k match or stock options that you’d get being a W-2 employee. However, there are a lot of advantages of being a 1099 independent contractor that you don’t get being a W-2 employee, such as the ability to write off your business expenses in a very clean way.

Another thing that came to mind while you were talking is I personally, as I’ve mentioned before, am self-employed, and while I do have a savings goal for my self-employed income or rather a retirement savings goal, because of the inconsistent income, sometimes I’m not able to do it monthly. I know dollar cost averaging can play into how your retirement savings pans out. So then how does that dollar cost averaging work for people who are like, “Hey, you know what? I’m just going to save for retirement quarterly or every time I get a lump sum of money?”

You know what? That’s totally okay, and in fact, I’m a huge fan of the year-end… We call it true up, where by the end of the year, if you were not able to consistently save biweekly or save on a monthly basis, if by the end of the year, you can still true up to make sure that by December 31st you’re able to put in what would true up to roughly 10% of your pay into a 401k, that’s totally okay. Obviously, you want to be able to get the fund into the plan as quickly as possible, but we wouldn’t see a huge variance in end result if you’re just truing up by the end of each year, meaning by December 31st you’re able to just dump in enough to get you up to 10% of pre-tax savings or after tax savings, whatever your focus is, based on a plan you’ve worked out with your tax advisor, that’s totally okay, too.

Okay. That’s good to know. So you’ve been mentioning 401k, SEP IRAs. Let’s get into the actual retirement accounts that self-employed people can use. Can you run me through the basic accounts and also the benefits of each?

You essentially have different types of retirement plans that are qualified under something called defined benefit plans, which are more like traditional pensions, and then you also have defined contribution plans, which are more traditionally 401ks. One of the things that you’ll want to do is figure out what are you using this plan for? Do you want access to it now, or are these funds that you’re never planning on touching until you’re age 59 and a half or when you plan to fully retire post-59 and a half? Because different plans have different rules on when you can have access to them versus others.

So for example, the 401k is a plan that can be set up for both W-2 employees through an employer or you can also set up a 401k as a self-employed person setting up your own plan. For example, let’s say you have your own company. You’re the only employee. You can set up something called a solo 401k. It’s essentially your plan as a business owner. Even if you have a spouse or significant other who works within your company, that person, if they’re a spouse, can also have access to your solo 401k. That solo 401k is specifically for folks that don’t have other non-spouse employees. So both you and your spouse or domestic partner can have access to that solo 401k as well.

So, Ayesha, can you run us through… I personally have a SEP IRA. That’s the one I use. So you can run us through what SEP IRAs are and also SIMPLE IRAs as well?

Yep. So a SEP IRA and a SIMPLE IRA are specifically IRAs for self-employed individuals. It’s important to note who can have a SEP IRA or who can have a SIMPLE IRA. Do I have to be an LLC? Do I have to be a C-corp or an S-corp? If you’re self-employed, even if you’re a sole proprietor, you can have any of the retirement plans that we’ve talked about. A SEP IRA, you can have a SIMPLE IRA, you can have a solo 401k, of course, depending on the number of employees you have, or you can have a traditional 401k plan. These plans are designed specifically for anyone who has 1099 income, you’re an independent contractor. There’s so many different ways of structuring these. A SEP IRA and a SIMPLE IRA, how much you contribute is going to vary depending on which type of plan you set up.

So a SIMPLE IRA, for example, is a plan that, very similar to a 401k, you’re employee. So if you’re the employee or your spouse or domestic partner is the employee, they’re going to save a percentage of their income as an employee and as the employer, which you can be both the employee and the employer of your company. If you’re self-employed, you’re also going to provide an employer match. That’s how a SIMPLE IRA works. A SEP IRA is done a little different. All of the contributions are made by the employer. So as a percentage of your overall pay, your employer is essentially contributing for themselves, their domestic partner, or spouse. That percentage of their pay is going into a SEP IRA.

So how does that work if you’re a one-man business? How do you end up having to match your pay?

If you’re a one-man business or one-woman business, you are in essence still multifaceted in the sense that you’re both the employee and the employer. So if I have myself on payroll, for example, if I’m paying myself a salary of $50,000 a year from my business, if I’m contributing 10% of my pay, which would be $5,000 as my employee contribution, then as the employer I can do a match on my pay of either dollar for dollar up to a certain percent or 50 cents on a dollar up to a certain percent. Also, as the employer, in addition to the employee match, I can also do other contributions like profit sharing contributions.

So if the business does very well, I can contribute both as the employee, I’ve got my employee contribution, then I’ve got my employer match, and then if the business has a great year I can do an additional maybe 10% of my pay or 15% of my pay as a profit sharing contribution as well. So there are different sources of money that you can put into the plan, but it’s important to note that when you’re self-employed, not only are you the employer, but you’re also the employee, which is another reason why it’s a really good idea to have yourself on payroll so that you and your accountant can sit down and figure out exactly what percentage of your pay are you contributing to this plan?

While we’ve been mostly throughout this series talking to people who don’t have multiple employees, or like myself are just a one-man or woman business, what about planning for the future? What about people who maybe in the next couple years might decide to expand? Which retirement accounts may be ideal for them?

I generally tell folks, even if they’re new businesses, to somewhat begin with the end in mind, which is a quote I got from Stephen Covey, I think it’s Stephen Covey, many, many moons ago, even if it’s just you operating your business as both the employer and the employee. Maybe you have a spouse or domestic partner who’s also in your business. Most folks will say, “Well, I can set up a SEP IRA because it’s just me running and operating my business.” I really want folks to think about it. I encourage folks to think about, “Where do you see yourselves going with your business? Where’s your business going in one year, three years, five years, 10 years?” If you plan on maybe hiring someone in three years full-time or even if you plan on in the first three years of your business possibly having seasonal employees or part-time employees and you think that you may have that person working through your business as a W-2 employee, I’d say start the retirement plan based on where you think that business is going.

I’ve seen a lot of folks say, “All right, well, it’s just me,” and they start a SEP IRA, for example, and then a year later the business is doing very well and they have to hire someone full-time as a W-2 employee, and they’re like, “What do you mean, I have to put 25% into their retirement plan as well?” That’s a huge expense for a relatively new business. So it’s a part of the reason why we start having folks think, all right, if you think you’re going to bring in someone sooner than later, I’d probably already start out with a retirement plan that would be based on the expectation that I may have some employees.

I personally want to save as much as possible so I can retire before the set retirement age. I’m sure some people out there want to also. With that said, can you have multiple of any of the accounts that you mentioned at once, or is it that if I open a SEP IRA, I can only have that? So could I have an IRA, a SIMPLE IRA, a SEP IRA all at the same time?

There are maximums that you can put into your plan, so what I would do is I would sit down with my tax advisor to make sure that I’m not exceeding the combined maximum on all of those plans. Very rarely do I see someone who has a business that has a 401k and a SEP IRA for that same business because you want to make sure that you’re within the limits of how much the IRS allows you to put into a defined contribution plan, for example. You can have, for example, both a traditional IRA or a Roth IRA and a SEP IRA or SIMPLE IRA and you still get the maximums that apply to traditional and Roth IRAs and the maximums that would apply to your SEP or SIMPLE IRA.

The same with a 401k plan. I could have my own solo 401k plan, for example, still have a traditional and Roth IRA, and still get the limits, the maximums, that I’d get on both my 401k and I’d also still be able to max out my Roth IRA, for example, provided I’m within the income limits. So I always encourage folks to sit down with a tax advisor to make sure that you’re not over contributing.

My wheels are turning. How do I make more money to put inside my retirement account? So are there any advantages? I know you have mentioned a few, and, actually, we were just discussing one, which is that you could potentially put away more money than a nine-to-fiver. But are there any advantages to the retirement savings process as a self-employed person that nine-to-five individuals don’t have?

Sure. If you’re a W-2 employee, you have a very hard limit on how much pre-tax you can put into your 401k plan. That number that you can put in pre-tax as both the employee… If you’re self-employed, you have your employee contribution limit that you’d get if you were a W-2 employee somewhere else. You’d get that limit. Then you also get the amount that you can defer from your business, also pre-taxed, both between the employer contribution and the profit sharing contribution. So, in essence, if you’re self-employed, you can get in north of $60,000 a year, all pre-taxed, from your business. You’d never be able to do that much, defer that much pre-taxed if you were a W-2 employee.

Good to know. Those who are listening, this doesn’t mean you should go quit your job, but very good to know. But maybe you should, I don’t know. All right. So moving on next. I heard some people use mutual funds or index funds and like to house their investments for retirement there versus using one of the tax advantaged accounts that we’ve mentioned, like an IRA. So are there any benefits to this, especially for self-employed people?

I’m so glad you said that because I want to give some clarity to what you can put into what are called qualified plans, like a 401k, IRAs. They’re tax-deferred. They’re qualified plans. So these terms, a 401k, a traditional IRA or Roth IRA, all these are tax codes. This essentially just tells the IRS how you can put money into this pre-tax or after tax and then, when you turn 59 and a half, how you can take money out of that plan, whether it’s taxable or tax-free. So that term, 401k or traditional IRA or SEP IRA, these are just tax codes. How I liken them is think of these tax codes like a glass, just a regular mug or glass, and you can put anything you want inside of that glass. So you can put orange juice inside of a glass. You can put water inside of a glass. You can put coffee inside of a glass. If it’s 5:00 somewhere, you can put gin and tonic inside of a glass, get a little spicy.

These are how tax codes work. Essentially, what you put into that glass, that’s the strength of it. That’s the flavor of it. 401ks, IRAs, it’s the exact same. I can put whatever I want inside of that glass, inside of that tax code. I can put mutual funds in a 401k or IRA. I can put ETFs, index funds. I can put individual stocks. I can put money market accounts, which is a cash equivalent. I can put CDs. I can put anything I want inside of these plans. Just like outside of a qualified plan, I can have mutual funds, or I can have exchange traded funds or ETFs or index funds. I can have all of those outside of a qualified plan. But I can also put those inside of a qualified plan. So all the things that you just mentioned that can be in a regular brokerage account, think of that tax shelter as just a code that tells the IRS, “When I sell this mutual fund and when I take money out of it, how do I pay taxes on it?”

All right. So the last question I have for you, Ayesha. For people who are self-employed, who are maybe thinking in the next 10 years to expand their business, but who don’t want to have this business for the rest of their lives and maybe have thoughts of selling their business eventually, even to fund their retirement… So let’s say you have someone who says, “I own this business and I plan to grow it and then sell it and live off of that money for the rest of my life.” Do you think it’s a good idea to plan to fund your retirement using this strategy? What are some of the risks?

Absolutely. Most people build a business for a potential exit, right? What is my out here? Selling a business and having the valuation of that business be what will ultimately fund your retirement can be a great idea. The risk of that is the business flops or doesn’t go anywhere or regulation comes in and you’ve put all your eggs in this one basket and there are regulatory changes that substantially change either the cash flow of the business or how that valuation number is projected. So I believe in diversification, but it’s totally okay to think about using your business valuation as being, “This is what I plan on using as my retirement nest egg.”

If that’s the only thing you’re going to do, you’ve just got to be really, really sure that you’re going to be able to sell that business for what you think the current valuation and future valuation will be. Just be very aware that sometimes there are different industries where either regulations come in, or with the fast-developing AI and some of this technology, will that ultimately diminish what kind of business you’re building, and will that ultimately diminish its value? So those are things that I’d say just be a bit aware of and a part of the reason why I’d say you should probably think about diversifying that retirement nest egg because having all of your eggs in one basket can obviously be a huge risk.

Yes. I’m with you. Before we go, for anybody out there who is still hesitant, specifically self-employed people, about saving for retirement, do you have any last words for them?

Get started where you can. Build the habit early. It’s so easy to fall into the traps of making sure that all our expenses are paid, both business and personal, but the earlier you can get started setting aside money for both emergency reserve for yourself or for your business and ultimately for retirement, the better off you’ll be.

Love that. Thank you so much, Ayesha. Ayesha Selden, thank you so much for your help today. We appreciate you.

Life be life-ing. I love that line from her. But one of my big takeaways from your conversation with Ayesha is how much flexibility people have when it comes to when and how they fund their retirement, no matter what type of account or accounts they’re using. Given how up and down income can be when you’re self-employed, it is really reassuring to hear that people don’t need to make contributions from every single paycheck to be on track. True upping contributions before the end of the year is a great tactic there. But, Elizabeth, I am wondering now, are you rethinking how you’re funding your retirement as someone who runs their own business?

Yes, Sean. So I am a lump sum queen. I do love to pay in lump sums, not only because my income is inconsistent but also because sometimes I want to spend my money on other things, to be honest. But I think from this conversation I’ve realized that there’s so many options that self-employed people have, especially when it comes to saving for retirement and building wealth. Also, I think I may look into putting myself on payroll to make all the math easier, too. Then, after listening, I also feel motivated to open a few other self-employed retirement accounts, just to maximize my savings.

Well, I also really liked Ayesha’s advice about thinking about where your business is going to be in the future. Retirement planning is all about what’s happening years down the road, and similarly it’s a good idea to set up your business’ retirement plans according to where you think your business will be in the future. All right. Well, Elizabeth, tell us what’s coming up in episode four of the series.

My heart is breaking. It’s the last episode for this series.

I know. But we have so much more ground to cover, don’t worry.

In episode four, we’re going to tee up this series by talking about how to incorporate your business as a self-employed person or whether you should at all. We’re going to get into the pros and cons and hopefully give listeners clarity about what is best for them.

These are basically business structures that allow you to separate yourself from your business, i.e. your business is essentially its own entity and you are a operating member or a partner or owner or shareholder in that business.

For now, that’s all we have for this episode. Do you have a money question of your own? If you do, turn to the Nerds and call or text us your questions at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Also, visit nerdwallet.com/podcast for more info on this episode, and remember to follow, rate, and review us wherever you’re getting this podcast.

This episode was produced by Tess Vigeland. I helped with editing. Courtney Neidel helped with fact-checking. Sara Brink mixed our audio. And a big thank you to NerdWallet’s editors for all their help.

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