I could retire today if I die by the end of the month

Solopreneur Retirement (Part 2): IRAs for Solopreneurs

Solopreneur Retirement Series (Part 2) – IRAs for Solopreneurs

 Part 1 of the Solopreneur Retirement Series:  Pay Yourself First focused on the needs of solopreneurs, freelancers, business owners and self-employeds. We stressed that we need to remember we are separate from our business. We took a look at:

In the gig economy, there are no benefits, no guarantees of minimum wage, no guarantees of a steady paycheck, no company sponsored retirement savings plans or saving into social security.

 In Part 2, we’ll a look at IRAs for solopreneurs: The SEP IRA (Self-Employed IRA) and  Roth IRA.

Part 2 – The SEP IRA and Roth IRA

What is a SEP IRA, and why should I care?

  • Much larger contributions than Traditional IRAs
  • Best for those with no or few employees
  • Only pay in for yourself as an employer (but then also have to pay in for employees)

A SEP IRA (Simplified Employee Pension) allows for greater contributions than a traditional IRA. A traditional IRA limits contributions to $5,500, (or $6,500 if you’re over 50.) With a SEP IRA you can stash pre-tax dollars up to the lesser of:

  • 25% or your net income, or
  • $55,000

Another cool feature about the SEP IRA is that you can contribute as much or as little as you want each year. This means that you can contribute more when things are going well, and back off or even skip contributions during a downturn.

A SEP IRA is best if you have few or no employees

A SEP IRA mandates that whatever percentage of compensation you contribute to the plan for yourself for any given year, you must also contribute that same percentage on behalf of each eligible employee. For example, if you allocate 15% of your net income in 2018, you also have to contribute an amount that represents 15% of each employee’s net income (out of your pocket) for that same year. Obviously, this can get expensive.

An eligible employee is someone who:

  • has worked for you for 3 out of the last 5 years
  • is at least 21 years old
  • has made at least $600 working for you in the previous year

Employees themselves are not allowed to contribute to a SEP IRA. However, if you are an employee, you can both receive employer contributions to a SEP-IRA made on your behalf, and make regular annual contributions to a traditional or Roth IRA for yourself.

What is a Roth IRA and how is it different?

You contribute your cash after you’re taxed on it

Just like a Roth Solo 401(k), a Roth IRA has you making contributions after taxes as opposed to contributing pre-tax dollars in a traditional IRA. You contribute your cash after you’re taxed on it.

Why might you want to do this?

While you won’t get that break on your taxes today, you won’t have to worry about paying taxes on your contributions or their earnings when you withdraw your funds after you are 59½. This may be to your advantage if you believe you might be in a higher tax bracket in the future. And your earnings  from your investments? You can cash them out tax free if you follow the rules.

Can anyone open a Roth IRA?

One aspect of the Roth IRA that is different from the SEP is that your AGI (Adjusted Gross Income) needs to fall into a certain range in order for you to qualify. It’s totally possible that you earn too much income to be able to use a Roth IRA. Generally, you can contribute to a Roth if your adjusted gross income is less than:

  • $196,000 for married filing jointly or qualifying widow(er)
  • $133,000 for single, head of household, or married filing separately and you didn’t live with your spouse at any time during the year
  • $10,000 for married filing separately and you lived with your spouse at any time during the year.

Mixing IRAs to diversify your tax liabilities

Having a Roth in addition to a traditional IRA can help diversity your tax liability upon retirement. For example, you can have a Roth IRA and a traditional IRA, but you can’t contribute up to the max for each. Instead, you could contribute 50% of the allotted limits to the Roth, and 50% of the limits to the traditional in order to hedge your taxes. While you would be taxed on the withdrawals of the traditional IRA, you would be able to withdraw the earnings and contributions held in the Roth tax free.

A traditional IRA and a Roth IRA have to split contributions because they share the same limit, But a SEP IRA and Roth IRA do not cancel each out. This means that you can contribute up to the max in each. For example, you can contribute up to 20% of your net income (or $55,000) to a SEP and you can contribute $5,500 ($6,500 if your over 50) to a Roth.

Questions to Ask When Setting up an IRA

1) What investment strategy should I choose?

With an IRA, you have many choices for investments, including mutual funds, exchange-traded funds and individual stocks with relatively small operational costs. You can decide your own investment strategy.

In Part 1 of this series, we discussed some really good reasons for looking at passively managed index funds. Now we want to draw your attention another strategy:  investing in companies that have strong environmental and social policies because these types of funds have been beating the market. Swell Investing offers both IRAs for solopreneurs. And the great thing about Swell is that you don’t need a broker and it is very easy to set up your accounts and automate them.

Swell Investing
The MSCI KLD 400 index, which tracks companies with high environmental and social impact, has outperformed both the S&P 500 and the Russell 3000 on an actual and risk-adjusted basis for the past 25 years. – Swell Investing

Should I invest in passively managed funds or sustainable investments?

Gotta be honest, right now the WellWallet investment philosophy is to get the best of both worlds:
  1. Open a retirement account at Vanguard and invest 50% in passive index funds. (See Part 1)
  2. Open an account at Swell and invest 50% in impact investing.
  3. Then – Automate it. Automate it. Automate it.

(You will be surprised at how much you will have in 6 months to a year.)

Top Reasons For Choosing Swell Impact Investing

Low Cost – No expense ratio or trading fees

Because you own the stocks in the Separately Managed Accounts (SMAs), there are no expense ratio fees like you find with ETFs and mutual funds. You don’t have to have a separate brokerage account to tradeTrading is all included on their impact platform.

Rigorous selection criteria

To be part of Swell’s impact investing portfolios, companies have to pass two strict tests:

  1. They have to get through strict criteria to prove their environmental and social performance.
  2. They have to score high on financial potential.
Broad diversification and solid performance

With Swell Investing, you can choose which issues matter most to you, and invest your dollars to actually make a difference in the world. You can create a customized portfolio mix of companies across a variety of socially responsible themes according to your interests.

Investors can choose from 6 different themes today (Check out the one year performance as of August 10, 2018):

  • Green Technology (+10.63%) – Think electric cars and LED lights.
  • Renewable Energy (+8.06%) – Think wind turbines and solar panels.
  • Zero Waste (+14.56) – Think recycling and repurposing.
  • Clean Water (+15.29%) – Think water filters and pipe repairs.
  • Disease Eradication (+16.70) – Think immunizations and research.
  • Healthy Living (+31.39%) – Think nutritious foods and health centers.
  • Swell Impact 400 portfolio. Diversify across 400 companies. Every one of these companies follows the 17 UN SDGs.
Swell Investing is one of the most successful sustainable investing platforms around today. Anyone can join for $50 (and Swell will match it with another $50).

Choices and simplicity

Swell offers both a SEP IRA and a Roth IRA. It is amazingly easy to set up an IRA with Swell. Their minimum investment is only $50 and they are currently matching that with an additional $50 bucks, for free!

2) Loans: Can you take loans from your IRA plan?

Technically, you cannot borrow money from your IRAs like you can from a 401(k). (Which we wouldn’t recommend anyway if you could, unless it was super serious and between you and a credit card or high interest personal loan.)

3) Rollovers:  Are they allowed into and out of the plan?

Logically, Roths can’t be rolled over into pre-tax IRAs and pre-tax IRAs can’t be rolled over into Roths for obvious reasons. While it’s common to roll an employee’s 401(k) into an IRA when employees leave the company, it’s debatable whether those funds can be rolled back from an IRA to a 401(k). Make sure you check the rollover policy for the each of the plans you consider at all instances of making a move with your funds because laws change frequently.

Last Tip: Rules about Withdrawing funds from SEP and Roth IRAs: 

Withdrawing from Roth IRA:

You can withdraw your contributions to a Roth IRA without penalty at any time. (You paid taxes up front on these, remember?) But you can’t withdraw earnings on those contributions before you are 59 1/2 without a tax penalty.

Withdrawing from SEP IRA:

While you can withdraw your funds from a SEP IRA at any time, they will be subject to taxation and a penalty tax before the age of 59 1/2.

Both business owners and employees  participating in a SEP over age 70 1/2 must take required minimum distributions from a SEP-IRA. This means that even if you haven’t retired by age 70 1/2, you still have to take required minimum distributions.

For more information on withdrawal rules from the IRS themselves, go here for Roth IRAs and go here for SEP IRAs.

Tune in next week for the next issue of The Solopreneur Series where we will continue our discussion on thriving as a Solopreneur. We will cover more retirement funds options such as HSAs (Health Savings Accounts), business structures, taxes, cash flow management, and more…


More from our lawyers: Well Wallet, PBC (aka WellWallet) is an informational platform for personal finance, and unless specifically stated otherwise, the content is provided to you without charge. WellWallet is not a financial planner, broker, or tax advisor. We cannot provide any advice for your specific financial situation. Our goal is to help you understand how to better manage your finances and how your finances affect your life goals, but we can never make any guarantees about your financial future (or present). The material here is meant for informational purposes only.  It should not be considered legal or financial advice. See our Terms & Conditions for more information.

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