You started your practice to have more control, freedom to choose certain clients (and fire others) and potentially, make more money. Hopefully, all or at least most of these are occurring, but I imagine it’s still challenging to save for retirement while running your practice.
You’re in great company. Across industries, small business owners habitually under save.
Let’s explore why it’s hard to save, how you should be saving and a few of the vehicles you can use to jumpstart your retirement savings.
Before we dive in, note that the following items are presented for educational purposes only. Nothing here is or should be considered specific financial advice for you. As your situation is undoubtedly nuanced, you should seek the advice of financial and tax professionals before utilizing the strategies mentioned.
Why It’s So $@&% Hard to Save
You have less time. Back when you were an employee of someone else’s firm, things were straightforward. You got paid and a portion of your income was whisked away to your 401(k) account. (If you were lucky, your firm contributed as well.)
And that was it. No watching the corporate bank account. No reconciling books. No paying quarterly estimated taxes. No wondering why clients don’t pay on time.
Now you’re pulled in 100 directions, and running your firm (not actually practicing) usurps countless hours.
No existing plan. This goes with lack of time. You don’t have a retirement plan to plug in to — you must set it up yourself or hire someone to do it for you. Many solos find this to be a surprisingly large hurdle. “I’ll do it next year … ” turns into half a decade quickly.
You see all the money. When you were an employee of someone else’s firm, you likely never saw the firm’s gross revenue and you definitely didn’t have access to the firm’s bank account(s) to watch client payments actually being deposited. But now, you see everything. Daily, weekly, or monthly, you see each incoming client dollar.
What’s wrong with this?
Once seen, those dollars “without a plan” cannot be easily unseen and squirreled away in a retirement account that you won’t be able to access for multiple decades. So, those dollars end up in one of the two places: (1) back in the business and/or (2) your personal bank account.
What to Do?
Automate your savings and pay yourself first. If you’re receiving a regular paycheck from your firm (even if you’re self-employed) carve out a portion for retirement savings and think of it as a regular “expense” that must be paid.
If you prefer to make an annual profit-sharing contribution, build that contribution into your firm’s 12-month financial forecast. When you put parameters around retirement savings goals, they have a higher probability of occurring.
Savings Vehicles for Solos and Smaller Firms
Potentially high contribution limits: the lesser of $55,000 (for 2018) or 25 percent of compensation
Easy to set up and very low costs to start and maintain
Contributions are deductible as a business expense
Funding flexibility — the employer does not need to make contributions annually
No plan tax filing with the IRS
Solo 401(k)s work well for solo practitioners who are self-employed and do not have any employees other than a spouse. Lesser-known fact: a solo 401(k) may also be used for a partner/owner-only business with no employees. A solo 401(k) recognizes you as both the business owner (the employer) and the employee.
Potentially higher contribution limits than with a SEP-IRA and more flexible funding options.
As the employee, you may defer up to $18,500 (for 2018) of your salary into your solo 401(k) account. Those 50 and older may make an additional $6,000 catch-up contribution, bringing their total to $24,500. If you’re making those contributions pre-tax, they will lower your taxable income.
As the employer, you may make profit-sharing contributions up 25% of compensation, up to the 2018 maximum of $55,000.
Note: the above limits work together. For 2018, let’s say you are 45 and defer $18,500 of your W-2 salary into your solo 401(k) account. You, as the employer/firm owner, may now make a profit-sharing contribution of up to $36,500 to your solo 401(k) account as well. $18,500 of salary deferral + $36,500 of profit-sharing = $55,000 (the 2018 limit).
Want to make Roth 401(k) contributions? No problem. Assuming your plan allows for them, your salary deferrals may be made as Roth deferrals.
Cost — low if you’re using a major custodian, i.e., TD Ameritrade, Fidelity, or Schwab
Compliance testing — none.
Points to consider
Filings — once plan assets exceed $250,000, you’ll file an IRS Form 5500 annually. (This is not difficult.)
If you have any eligible employees, you cannot use this plan.
Set-up — while not difficult, getting a solo 401(k) up and running is a little more complicated than starting a SEP-IRA.
Don’t use a SIMPLE IRA for your practice.
Yes, they’re simple to set up (pun intended) and inexpensive. However, the contribution limits are much lower, $12,500 (for 2018) and $15,500 if age 50 or older, compared to SEP-IRAs and 401(k)s. This hurts you and your employees. Also, as the employer, you’re forced to contribute following one of a few available methods.
If you have eligible employees and don’t want to use a SEP-IRA, consider setting up a 401(k) plan. There are a variety of small business or “startup” 401(k) vendors with very cost-competitive offerings.