When you’re a corporate employee – if you’re lucky – you have a company-matched 401K and maybe even a fully funded pension plan. When you’re self-employed, saving for retirement is all on you. And unless you want to still be working when you’re old and gray, it’s a good idea to start saving sooner rather than later.
The good news is, the government makes it easy – and tax free – to build up your own personal retirement account.
401K or IRA
A 401K is a special type of retirement fund set up and administered through an employer. Some companies offer to match a percentage of every dollar you contribute, making this a nice, pre-tax benefit.
IRAs, or Individual Retirement Accounts, are set up with the help of a bank or financial planner, and are also non-taxable. That means that if you’re paying 30% of your net income to the IRS (not uncommon for self-employed folks) you can save 30 cents on every dollar you contribute to an IRA.
There’s a limit to how much you can invest in a retirement account. For individual 401Ks (available only to self-employed persons with no employees), the maximum you can stash away pre-tax is $17,000. For IRAs, it’s $5,000.
Before you start stashing money away, though, remember that this tax savings does come with a price: You can’t touch the money you invest until you’re 65, or you end up paying not only the income tax, but penalties as well. In addition, you will have to pay income tax on that money when you retire. There’s no escaping the tax man entirely, unfortunately.
A Sound Investment?
There’s another benefit of a retirement savings account: the potential to earn substantial interest rates. Because you have the flexibility to divide your IRA funds up among various investments, you can potentially see returns as high as 10 or 12%. That’s a far cry from the 1% your savings account is offering.
Of course, there’s no guarantee that any investment will earn money. Just talk to anyone who was close to retirement age when the economy took a downturn in the early 2000s. Many people saw their 401ks and IRAs dwindle away to nearly nothing, while they stood helplessly by and watched.
But for saving on your income tax as a small business owner, an IRA or individual 401K is ideal. They’re easy to set up and have few costs involved, plus they give you the freedom to invest your money in high-earning stocks or to choose safer bonds.
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