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PPP006: How Do I Automate Retirement Contributions when Self Employed?

Today Carrie in Seattle asks us how to handle her retirement contributions when self-employed. Lucky for her, there are retirement accounts just for self employed individuals.


Concepts Discussed

Resources Mentioned

Full Transcript

Eric Rosenberg: Ladies and gentlemen, boys and girls, children of all ages, welcome back to the Personal Profitability podcast. This is episode number 6 and features a reader question from Carrie in Seattle. Carrie is self-employed and wants to know a little bit more about how she should deal with her retirement accounts and her retirement planning which can be a challenge for self-employed people. So let’s turn it over to her for her question.

Hi, Eric. I’m a freelance consultant and I manage all of my own personal finances as well as my business finances. One thing that I’ve been wondering about recently is, is there an easy automated way to continually put money into some sort of retirement account? I currently have a Vanguard account with my IRA and old 401(k) from when I worked for an employer, but now that I’m on my own, I’d love to find a way to automatically send a designated amount into a new retirement account each month. Is there a way to do this and if so, what account type do you recommend and what percentage of my income should I send there? Thanks so much.”

Eric: Well, thank you so much for that great question, Carrie. It’s a pretty common and popular question among self-employed people because with people who have a full-time regular eight to five type of job, with a large employer, that employer’s going to put together all of the investment and retirement account options for you for most parts, so your 401(k)s and whatnot, they are all set up for you. You just choose the funds and the percent of your paycheck you want to put in there. So that’s all pretty easy to put together for people with a full-time job. But if you are self-employed, you have to do everything yourself and that’s including picking the type of account where you want to have the account, what investments you want to use in that account, so all sorts of decisions that you don’t have to make when you have a full-time employer, but fortunately I can walk you through it. It’s not all that difficult.

So to start I actually just wanted to address one thing you mentioned in your question. You said you had an old 401(k) account from a prior employer, the first thing I would do before you do anything else is roll that over into a self-directed IRA. That works just like the 401(k) except it’s no longer attached to your employer, and you can choose any type of investment you’d like for that. You mentioned that you have some accounts at Vanguard. That’s a perfect place to do your rollover. You just call them up, tell them that you have an old 401(k) you’d like to roll over, and they’ll actually walk you through everything on the phone. When it comes time that your cash moves over, it will be a check they’ll either send to you or straight to Vanguard if your old 401(k) company will allow that. You can choose your investments. I would choose something like a Target Date fund or an S&P 500 Index Fund, something low-cost and easy that you don’t have to spend any of your time managing. Now that that’s out of the way, it’s actually pretty quick, it should take probably a 20 to 30-minute phone call on the high end of things. So it shouldn’t take a whole lot of time.

Investments and Savings Options

Eric: So now time to answer your big question. What do you do as a self-employed person when you want to save automatically? Automatic savings, your head’s in the right place. It’s definitely the best way to go because you don’t forget. You don’t have any oops and you don’t spend the money on vacations or whatever fun hobbies and things you like to spend your money on. So saving first is very smart and a great idea. So what I would do I would break your savings into two different spots, two different accounts. So first, something that anybody can use whether you’re self-employed or you have a full-time job from an employer, is a Roth IRA. How a Roth IRA works is you earn your money like normal, and you pay taxes on that income like normal, and you make contributions from the income you’ve already paid taxes on into the Roth IRA. It can grow forever tax-free until your retirement. So for young people especially this is a great account, and the maximum you can invest into that account in 2014 or 2015 is $5500 a year. So you can set up an automatic payment from your checking account. If you have a business checking account, you can set it up as a recurring ACH or recurring external transfer. Or you can set it up as a bill pay and the bill is paying yourself and you want to make sure to put your account number on there so if you open this at Vanguard or whatever brokerage you choose—I use Schwab, I have Vanguard funds—there are other ones like Fidelity or E-Trade or Scott Trade or Trade King. There are plenty of brokerages that offer these types of accounts. It’s best to go with one that you already like and are comfortable with. If you don’t have one, Vanguard’s great because they have so many investments to choose from at a pretty low fee, some of the lowest in the industry. I like Schwab because I already had some other accounts there and they have great funds as well. So either way it’s a great choice to get started with your Roth IRA. Now to get that $5500 per year automatically, depending on how your income works which different types of independent workers have different types of income. Some get paid all at one time during the month; some get invoices throughout the month. It’s up to you how you want to time your contribution. But to make sure you hit that $5500 per year, you will want to put in $458 per month or $105 per week in change to hit that $5500 per year. That is the IRS who sets the maximum you can put into that type of account. And I have one of those myself, so does my wife. We max them out every year. I’m recording this in March and this will go live in March. So if you’re listening to this any time before tax day in the year you’re listening to, because this will be good advice forever, you can make a contribution to a Roth IRA for the prior calendar year until you file your taxes or until April 15 if you can do an amended tax form. That IRA contribution will be counted in there. That actually goes for a regular traditional IRA as well which will lower your taxes. A Roth IRA won’t lower your taxes, but it’s better in the long run to do the Roth.

The second type of account which you can also do contributions and set up until you file your taxes is called an SEP IRA or Simplified Employee Pension plan; that’s what SEP stands for. An SEP works pretty much just like a 401(k) except you are the employer so it’s not this giant plan offered to hundreds or thousands or tens of thousands of employees. You pretty much run it all yourself, but it works very similar to an IRA or Roth IRA. It just uses the same type of rule structure as a 401(k). So the rules are to open an SEP, you have to either be a sole proprietor or some type of business owner if you have an LLC or something like that, but even if you haven’t filed the LLC or C-Corp paperwork, as a sole proprietor you can definitely open this. You just have to demonstrate you earn income on the side with a Schedule C on your taxes or whatnot. So if you file with a schedule C this is perfect for you. If you’re in a partnership you’re eligible as well. Both partners can open up an SEP. But you just have to earn some sort of self-employment income by providing some sort of service or product to be eligible. That’s who it’s designed for. So when you open that account up, you can open that again at Vanguard or Schwab or that big list of account providers I offered earlier. You call them up or go on their website and search for SEP. You just type in those letters, SEP or simplified employee pension plan, and that will get everything started. The rules for that are a little different. You can contribute up to 25% of your annual compensation with a maximum of $52,000 in 2014 or $53,000 for 2015. So if you’re really, really good at what you do and make about $200,000 a year, you’ll cap out at the maximum you can put in. Let’s say you make $100,000 a year you can put $25,000 a year.

And I would encourage you to put as much in there as you can afford. You don’t want to be starving or risk losing your home, not being able to pay your rent or your mortgage or anything like that but as much as you can afford to put in on top of that Roth IRA, the more the better because you’re paying yourself. You will have that money. It feels like you don’t have it now, but if you automate those payments into that account which is a pretty simple automation process, a bill pay or however you want to set that up with online transfers. You can usually set that up also within your brokerage account so within the SEP you can set up a timed recurring transfer in from another account which could be your business account if you’d like. So you if pay yourself on a regular schedule, you can just have that be a business expense to pay into your retirement account. So you can still open that again for the prior year up until April 15 or when you file your taxes. What’s great about that SEP, because it works like a 401(k), it lowers your taxes this year, and you pay your taxes then on your payments in the future when you make withdrawals so when it pays you out when you’re retired. Let’s say you make as a single person in the 25% tax bracket, for every $400 you put into that account, your tax bill is going to go down by a hundred dollars. I think that’s pretty sweet. I imagine that you do too so I highly encourage you to take advantage of all of this. Save as much money in your taxes as you can. You’re putting money away for your future and all is good.

So thank you again very much, Carrie, for asking your question and being a part of this show. If you or anyone you know out there in Podcast Land wants to ask me a question, just head to Click on the little hamburger icon at the top and click on Ask Eric. You can leave me a voice question there. And the next two questions featured on the show will get a free copy of Chris Gillibeau’s book, I have them sitting here right in front of me, “The Happiness of Pursuit,” and you’ll get your question answered as well. So please leave your questions.

And a huge favor for everybody listening out there for me, this podcast is now on the ITunes store so you can go on ITunes and subscribe. It would be a huge favor to me if you would just go in there and leave a rating. If you think it’s worth a 5-star rating, which I hope you do, please click that 5-star. Leave a comment, a sentence or two. It doesn’t cost you anything other than a few seconds, but it means the world to me and helps the show grow to help a lot of other people who have their finance questions.

Thank you, Carrie. Thanks everyone for listening and being a part of it. We will talk to you next time. Thanks for listening to the Personal Profitability podcast. Go out there and make some money. Bye-bye.

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