Does Being Self-Employed Mean You'll Have to Work Forever?

Man working in his home office
Self-employed people by definition must rely on themselves for their paychecks and their insurance. And then there's retirement funding. Without the benefit of a company 401(k) (and the potential employer match), saving for the future falls entirely on their own shoulders.

That's a lot to take on. Perhaps too much, if you look at the results of a recent TD Ameritrade (AMTD) study.

The company's Self-Employment and Retirement Survey found that even though the majority of self-employed people think that they'll live on their savings when they eventually stop working, 70 percent of them are not actually saving for retirement on a regular basis:
  • 28 percent of self-employed people report that they aren't saving for retirement at all.
  • 40 percent aren't saving regularly.
  • 83 percent have put their retirement savings on hold or cut back at one time or another, compared to only 70 percent of people who are traditionally employed.
While you might think that self-employed people assume they can live off their business profits, only 19 percent plan to fund their retirement through profits from the company which will continue to run after their retirement -- and only 14 percent think they'll be able to sell their business and live off the profits from the sale.

"One of the biggest challenges that self-employed people face is irregular income, so opening a retirement account is sometimes not top of mind," says Lule Demmissie, managing director of retirement at TD Ameritrade in Jersey City, N.J. %VIRTUAL-article-sponsoredlinks%"But, once you have an understanding of what type of account is best for you, just go ahead and open it. You don't have to fund it right away, but having it open will make it easier to contribute money when you do come into a windfall. Having the foundation in place is a critical first step."

However, the picture is not entirely bleak for self-employed people.

When it comes to retirement readiness, the size of one's retirement account doesn't show the full picture, says Guy Penn, principal and founder of G.M. Penn Wealth Management in St. Louis.

A critical element not accounted for in the TD Ameritrade study is the self-employed person's unique capacity for income production, Penn says. "Many times, self-employed individuals forgo maxing out retirement savings to retain earnings in the business, and build an income-generating asset in the business itself."

And then there's the question of a person's need or desire to retire. "It's also very common that the self-employed love what they are doing and don't feel the desire to exit at 65," Penn says.

Retirement Tips for Self-Employed People

If you're self-employed and aren't preparing for retirement, financial advisors have several recommendations to help you get started.

"When I help self-employed folks, there are three questions that are important to help set up the correct plan for them," says Jeffrey Cutter, a CPA and PFS and owner of Cutter Financial Group, LLC in Falmouth, Mass. "First, how much do they make? Next, how much can they put away? Finally, do they have employees?"

Here's an overview of different retirement savings options for self-employed people.

SEP-IRA (Simplified Employee Pension). SEP-IRAs have a much higher contribution limit than traditional or Roth IRAs. The limits are based on a percentage of net profit for the self-employed. This plan works well for small, closely held partnerships, as each participant must be offered the same benefits under the plan.

"For higher-net-income folks who want to put more away, a SEP-IRA may be the best solution," says Cutter. He points out that a SEP-IRA is easy to maintain, offers many investment choices, and can be flexible in how it's funded. For 2014, an employer can contribute 25 percent of compensation up to a maximum of $52,000 per year.

Individual/Solo 401(k) for small businesses and self-employed. "An Individual 401(k) is most suitable for self-employed individuals or a business owner with no additional employees other than a spouse or a child," says Demmissie. "It allows business owners to make both employer and employee contributions, providing the ability to maximize their personal retirement contributions and their business deductions. You might consider this type of plan if your business has irregular profit patterns."

Solo 401(k)s are among the best option for the sole owner/employee setup, or a business without full-time employees, Penn says. The contribution limits are significantly higher than other employer-sponsored retirement plans, up to $52,000 in some cases, depending on the net profit of the business.

SIMPLE IRA. A SIMPLE IRA (Savings Incentive Match Plan for Employees) offers employees a salary-deferral contribution feature along with a matching employer contribution. You might consider a SIMPLE IRA if your business has steady income and your employees want to make contributions to a retirement plan.

"The SIMPLE IRA is a good plan for those who wish offer an incentive for employees, but want to avoid the higher administrative paperwork that goes along with traditional 401(k)s," says Penn.

Profit-sharing retirement plan. For a business owner who has variable profits but wants to reward long-term employees by giving them a percentage of the company's profits, a profit-sharing retirement plan may be a good choice, Demmissie says. The plan is very flexible. "The employer decides how much he or she wants to contribute each year and can even skip years if necessary."

Take your future into your own hands. "Self-employed people are often the CEO, COO, CFO, and Director of HR, with so many decisions facing them on a daily basis," says Cutter. "Life is all about decisions; the ones we make and the ones we fail to make. If you haven't set up a retirement plan yet, decide today to get it done. The only person you're hurting is yourself."

For more information on retirement plans for the self-employed, see IRS Publication 560, Retirement Plans for Small Business.

Michele Lerner is a Motley Fool contributing writer and has no position in any stocks mentioned. The Motley Fool recommends and owns shares of TD Ameritrade.

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