A while back, I responded on Facebook to a question from a therapist on retirement plans for a solo practitioner. She decided to transition to working full time in her private practice, and a mentor told her she needed to have a plan to save for retirement. That’s an important topic, which I plan to cover more fully in my upcoming video course. However, I don’t want to hold off until then, so here are some basics.
So, like the therapist mentioned above, you take the plunge and strike out on your own. You no longer have a boss, or more accurately, you see your boss each time you look in the mirror. That’s a great feeling, and a great opportunity. However, it does come with some challenges, since you no longer receive employee benefits such as health insurance, tax withholding, pension or 401(k) plan, and more, so you have to take care of all these yourself.
On the other hand, you get to keep all the value you create, without handing over a significant fraction of it to an employer, plus, you get to deduct many expenses that reduce how much you owe in taxes. The tax code also allows you to set aside for retirement much more than you could as an employee. In short, there is a host of reasons why opening your own practice is a good thing, but it does require good planning and execution to make sure you do the right things at the right time to make the most of it.
Depending on details such as how much you earn, whether you’re married, and if so how much your spouse earns, what state and local taxes you have to pay, etc., there are several types of retirement plans you could open. This is a rich topic (no pun intended) with lots of options and important details, so the following is just an intro with some useful resources. Note that this is all general information that may or may not apply to your individual case, so consult with a financial pro before taking action.
If you earn income from work, you can open an individual retirement arrangement (IRA). These include Traditional IRAs and Roth IRAs. As of 2017, these allow you to set aside just $5500/year ($6500/year if you're 50 or older). The traditional IRA contribution may be made with before-tax dollars, but you pay income tax on withdrawals in retirement. Roth IRAs have to be funded with after-tax dollars, but are tax-free after that. If you make too much money, you may not be able to contribute directly to a Roth IRA, but there is a way around that (advanced topic for another time).
The SEP IRA is like a super-charged traditional IRA that allows you to set aside up to 25% of your compensation up to $54,000/year. The SIMPLE IRA is another good option to explore, but contribution limits are too complex to cover here. If your practice pays you a salary (e.g., you set it up as an S corp or as an LLC that’s taxed as an S corp), you can instead set up a solo 401(k) plan for yourself. With this, you can contribute more than 25% of your compensation up to the same $54,000/year (plus $6000/year catch-up contributions if you're 50 or older). You can read more at Retirement Topics - 401(k) and Profit-Sharing Plan Contribution Limits.
As someone pointed out on that Facebook thread, retirement plans don’t feed themselves, so you have to set things up to fund them. This is so true, and “paying yourself first” is the way to do so. Not only should you take a certain percentage of your business revenue for your salary and for profit (more on this in a future post), but you should also set up an automatic transfer into whatever retirement plan(s) you set up for yourself. If you automate this and have it happen as soon as your personal money comes out of your business account, you won’t see the money and won’t be tempted to skip making this contribution.
Personally, I had one of my LLCs set up to be treated as an S corp for tax purposed, and opted for the solo 401(k) as my main vehicle to save for retirement. I also make sure it’s funded by transferring money into that 401(k) each time money comes into my business checking account. How about you? Have you set up a retirement plan? Are you contributing enough to create a comfortable living for your golden years, or are you short-changing your future self?