Do you ever put on a clean pair of socks, or pull a clean bowl out of the cupboard for breakfast, and silently thank “past you” for setting yourself up for success? Now think about that tiny little mood boost and imagine multiplying it by 10,000. That’s what you just might feel like after retiring, knowing that your retirement savings are so strong that they might survive the complete annihilation of Social Security. (We all know that Social Security isn’t going to last, right? Or maybe it will kick in at age 87 by the time we’re retirement age.)
This article is about future-proofing your lifestyle by saving up for retirement. Many retirees, even today (with Social Security), find themselves struggling to afford the kind of lifestyle that they would consider decent. I know, I’ve talked to them myself!
Let’s cover three major kinds of retirement plans that we most recommend to therapy practice owners, depending on your circumstances: the Roth IRA, the SEP-IRA, and the Solo 401(k).
The Roth IRA: An Income-Restricted Option That Does Not Defer Income Tax
A Roth IRA is an option to strongly consider if your business hasn’t quite taken off yet, or if your 2020 income is relatively low for any other reason. As the title states, this option is income-restricted. If you made more than $139,000 (Single) or $206,000 (Married Filing Jointly) in 2020, you cannot contribute to a Roth IRA this year. If you made a bit less, then your maximum contribution might be lower than the default amounts of $6,000 per year (or $7,000 per year if you are age 50 or over).
Aside from an income restriction, the Roth IRA is a non-tax-deferred retirement option. This means that contributions are taxed first before you contribute them to your retirement account. In other words, it’s like funding your retirement account “out of pocket” because you can just transfer funds from your bank account into retirement.
Having an account that does not defer taxes has its advantages and disadvantages. In short, by choosing Roth you are betting that your income tax rate will be higher after retirement than it is now, because you are letting the money get taxed now. A significant disadvantage of the Roth IRA is that your money is unable to grow tax free. That is to say, with a Traditional IRA your funds grow pre-tax via compound interest, and then are taxed once when withdrawn.
Nevertheless, if your tax rate is low then a Roth IRA is worth a look! This kind of retirement account is relatively easy to set up.
The SEP-IRA: A Traditional (Tax-Deferred) Option, Especially for the Self-Employed
The SEP-IRA stands for the Simplified Employee Pension Individual Retirement Arrangement. The SEP-IRA is not income-restricted like the Roth IRA. Also, the SEP-IRA is tax-deferred just like a Traditional IRA.
Tax-deferred retirement accounts are good in all the ways that after-tax accounts like the Roth IRA are bad, and vice versa. With a tax-deferred account, you’re either betting that your current tax rate is higher than it will be post-retirement, or you’re happy to let your earnings compound tax-free (or both!).
A major advantage of the SEP-IRA is that you can contribute a lot of money into one! Your contributions are limited to the lesser of 25% of your income or $57,000. We at TL;DR recommend contributing 10% of your income to retirement, which allows quite a lot of wiggle room to pad the account when business is good. Like the Roth IRA, a SEP-IRA is easy to set up compared to other options, hence the “S” for “Simplified.” Also, you don’t have to make contributions every year.
This all sounds great, right? Well, there is one major caveat. If you have employees, you must contribute the same percentage to their SEP-IRA accounts, as long as:
- They are 21 years of age or older (Congressional ageism is alive and well!)
- They earn $600 or more for the year
- They have worked for your business for at least 3 of the last 5 years
Note that if you don’t have employees, the SEP-IRA may be an especially attractive option for you. But read on, because the Solo 401(k) is also designed for persons without employees!
The Solo-401(k), Solid But Complicated
The Solo 401(k) plan, as the name states, is much like the kind of traditional 401(k) that an employer would offer, except that it is for a single person. You cannot have a Solo 401(k) if you have employees (except for a spouse). Whether or not you have employees now, if you plan to hire employees in the near future, it might not be worth the cost of setting up a Solo 401(k).
This retirement plan has both a Traditional and a Roth option, so you can decide if you want your taxes to be deferred.
The main disadvantage of a Solo 401(k), or a 401(k) of any sort, is the administrative burden. This is a complex kind of retirement plan! Note that there is complexity with the set-up and the administration of the account, so you may need to pay a higher recurring fee to a broker in order to maintain your 401(k).
If you are comfortable with the paperwork involved, then a Solo 401(k) might be a better option for you than a SEP-IRA. The reason for this is a bit tricky: basically, with a Solo 401(k) you’re allowed to make both employer and employee contributions, acting as both employer and employee much like an S-Corporation owner/employee. This can let you contribute more money since you can make an employee contribution up to $19,500 (for 2020) and save on tax dollars, but the calculations run deep. Contact us if you want an estimate!
Other benefits of a Solo 401(k) include the aforementioned Roth option, the ability to take a loan against your 401(k), and catch-up contributions for people of at least 50 years of age.
While the Solo 401(k) is a strong option, we generally recommend the SEP-IRA for business owners due to its simplicity and flexibility.
Beyond all the nuts and bolts of retirement plans, our simple advice to you is this: Save at least 10% of your income for retirement, so that Future You will be thanking Current You. We bet you can almost hear your own words of gratitude echoing back to you from the future!
TL;DR: A solo practice owner has options to save for retirement. The Roth IRA has strict contribution and income limits, and your retirement savings will not compound tax-free. The SEP-IRA lets you contribute 25% of your net income. If you can stomach some administrative complexity, consider the Solo 401(k) option. Regardless of everything else, the best thing you can do for yourself now is to set up a plan to sock away at least 10% of your income!