It was with both excitement and naivety that I left my corporate job for the freedom of self-employment, failing to predict the insecurity that arises from the lack of a corporate safety net. For the self-employed, there is no welcome packet from HR outlining our retirement and health benefits - no payroll, tax withholdings, paid sick leave, or vacation time - just a blank page waiting for us to create something from nothing. So, do we just get by, or do we make the extra effort to put the systems in place, so both owners and their employees can thrive?
How do the self-employed get a quality retirement plan?
The financial services industry can help to put a similar safety net in place for the self-employed through retirement accounts. These accounts offer tax savings today, while also creating a tax-efficient place to invest and build a nest egg for your future self. Lower fees and advances in technology have made these accounts very accessible.
But why build a nest egg?
As we get older, it is a reality that we will no longer be able to do the things that we once did - whether it is due to physical or mental limitations or, that simply, priorities have shifted. Peace of mind in the next chapters of life is dependent on our ability to adapt as these things inevitably change – and having enough savings is a critical factor in making that happen.
Then why don’t we save?
According to a RAND Health and Retirement Study, just 13% of self-employed single-member firms have a retirement plan and the median balance of those plans is $51,000. These statistics tell me that there will be a lot of people who will always be working - they will have no choice. That is, unless they start now.
There was an article recently written by CNBC Personal Finance reporter Jasmin Suknanan, that gives insight as to why this is the case, “It’s easy to feel like retirement is so far into the future and that we have plenty of time before we need to start preparing for it. As a result, many would rather treat themselves to things they can enjoy right now instead of stocking away money for a future that’s decades away. This thought process is called hyperbolic discounting and it happens when we’re more inclined to make decisions that come with a more immediate reward instead of decisions that come with a future reward.”1
As a self-employed individual, I certainly don’t like being told what to do, by anyone - including my past self - so saving now is the only way for my future self to be the decision maker. And who wouldn’t want the freedom of choice to put their feet up, pursue a hobby, or continue working?
So, what’s a self-employed retirement plan?
For many of the self-employed, a Simplified Employee Pension Individual Retirement Account (SEP IRA or SEP) is a good place to save for retirement. There are other types of solutions that could work for you too, such as a Solo 401(k), SIMPLE IRA, Traditional IRA, Roth IRA, or Company 401(k) Plan, which is one reason to work with an Investment Advisor, so they can first understand your business and objectives, and then recommend the most appropriate solution. For this article, we are going to focus on the SEP.
Here are the characteristics of the SEP:
Contribution Limit: lesser of 25% of compensation or $61,000
Tax Benefit: lowers owner’s personal income on a dollar-for-dollar basis, which decreases personal tax liability
Compound Interest: contributions are invested in stocks, bonds, and alternatives and grow tax deferred
Withdrawals: after 591/2 and taxed as ordinary income
A SEP is easy to set up, has little or no administrative costs, and allows flexible annual contributions. One aspect to note, is that the owner must contribute equally for all employees who have worked three out of the last five years for the company - but any employee contributions are deductible on the income statement, which decreases self-employment tax as well as the owner’s personal income taxes. Also, it’s worth pointing out that self-employment tax isn’t an additional tax only for the self-employed - it’s just another name for the Social Security and Medicare that is withheld from the paycheck of wage earners.
So, how do I open a SEP?
You have two options - go through a broker or hire an Investment Advisor. A broker buys and sells securities on your behalf, but they do not offer investment advice. An Investment Advisor will give investment advice, in addition to buying and selling securities on your behalf. Most Investment Advisors charge an annual asset-based fee, while brokers traditionally make money through a commission on trades. The types of advice you can expect from an Investment Advisor include:
Planning: calculating and setting financial objectives
Investment Selection: risk appropriate asset allocation by objective
Rebalancing: sell securities that have performed well and buy underperforming securities
Asset Location: using the correct type of financial accounts for different objectives
Behavioral Coaching: facilitate good financial habits
A broker will provide a platform to open the account and place trades, but it will require extra work as you are the one to decide what investments to purchase and how to adjust risk as you approach retirement. A good Investment Advisor will ask a lot of questions and get a complete understanding of your objectives and risk tolerance, and then recommend a long-term investment strategy. On a recurring basis, they will meet with you to see what has changed and adjust if necessary.
I’m ready to save for my future and would like to work with an Investment Advisor. What’s next?
Contact Intent Investment Management (IIM). IIM is a Registered Investment Advisor dedicated to facilitating better financial outcomes through strong client relationships that are grounded in empathy, academics, experience, and education - not just an online portal or app.
Justin Wollman
Portfolio Manager
Intent Investment Management
415-717-2661
1Here’s why our brains make it so hard to start saving for retirement. Jasmin Suknanan. Published August 25, 2021. https://www.cnbc.com/select/why-retirement-saving-is-hard-according-to-behavioral-economics/
Additional Sources: Intent Investment Management, RAND Health and Retirement Study, and Internal Revenue Service