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In the past decade or so, the FIRE (Financial Independence, Retire Early) movement really picked up steam. Young people motivated to save their way to retiring in their 40s or 50s dove deep into the nitty-gritty of retirement savings to make the best decisions for their long-term benefit.
Today, with the coronavirus pandemic a present danger, there are many uncertainties about saving. Add to that the challenge of operating a small business in this peculiar period, and putting money away for the future seems out of the question. If you want to pursue these FIRE goals as best as you can given the circumstances, here’s how to save for retirement when you have your own business.
A Solo 401(k)
Before getting into the differences between IRA plans, let’s explore solo 401(k) plans. Relatively new in the grand scheme of saving plans, solo 401(k) plans operate just as a work-supplied retirement fund would. You make pre-tax contributions that lower your taxable income, and you cannot remove that money until a given retirement age without a penalty.
One feature specific to a solo plan is that you function as both an employee and employer, which increases your contribution cap relative to other 401(k) plans. In 2020, that cap was around $57,000.
If you don’t have any employees and want to put a lot toward your personal retirement funds, a solo 401(k) is a rewarding way to go.
Your IRA Options
In general, an individual retirement arrangement, or IRA, is the traditional way to save for retirement when you have your own business. It has several variations, including traditional, Roth, SEP, and SIMPLE.
Traditional vs. Roth IRA
The key with a traditional IRA is that you can deduct your contributions to this fund from your taxable income for the year you make them. This avenue saves you money up front, but taxes will apply upon withdrawal in retirement. Meanwhile, Roth IRAs deduct income taxes from contributions up front, but its distributions are tax-free later on. Plus, Roth funds have fewer terms, adding to your flexibility.
A SEP IRA is like a solo 401(k) for small business owners who have few employees. While this means that you’re making matching contributions for your employees, that feature will help you retain loyal staff members.
The last IRA type we’ll cover is SIMPLE. These plans cover mid-size and larger companies, offering a comparatively low contribution limit and mutual employer/employee matching. If this sounds like a traditional 401(k), that’s because it does share many of the same features. In essence, the difference between the two is that a SIMPLE IRA plan is unsurprisingly simple, while a 401(k) affords employees and employers current and future flexibility.
Choosing between these various plans is one step toward financial health. As you move forward, do all you can within the unpredictability of small business life to put money away consistently.