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Retirement Accounts for Independent Contractors

I have gone over some of the retirement accounts for those who work for larger companies and the differences between 401(k) and 403(b) retirement plans, but I wanted to spend some time going over options for those who own their own practice or have created their own company.  For those who are independent contractors and get paid via a 1099 and not a W2, the options for retirement accounts can be confusing and much more complicated than simply contributing to your employer sponsored account. Because I know many people who want to open their own practice or firm, as well as some that have already done so, picking the right retirement plan comes up fairly regularly.  However, because each person and their practice are unique I won’t be able to give you a one size fits all solution but hopefully that’s not what you’re looking for. For today I’ll simply be going over some of your options when creating your own retirement plan and if you’re interested in learning what’s best for you I’d be happy to walk you through that process.

Solo 401(k)

One of the most common and widely used retirement options is the individual or solo 401(k).  The solo 401(k) operates in much the same way that a company sponsored 401(k) does except that it does not have an employer matching mechanism.  However, to make up for that lack of matching it does allow you to contribute as both an employee and an employer. With a solo 401(k) you’ll be able to contribute up to $18,500 as an employee along with an employer contribution of 20% of net income up to the limit of $55,000.  One of the great advantages of a solo 401(k) is that while you can only contribute one employee contribution to a 401(k) account, that doesn’t limit the employer contribution. For example, if you work for a company with a 401(k) as well as being an independent contractor you’ll be able to contribute that extra $55,000 to the solo 401(k) as that contribution is plan specific.  This way you can take advantage of the employer matching program of the first 401(k) and then still contribute the max of the solo account.

So, let’s say that you’re interested in starting a solo 401(k), the next questions are usually “How do I start this plan?” and “What features do I need to look for?” so I’ll go over those questions now.  A solo 401(k) can be started at the large brokerages or mutual fund companies such as TD Ameritrade, Schwab, Fidelity, or Vanguard. You will also need an Employer Identification Number (EIN) which is free and can be accomplished online in a only a few minutes by filling out this form.  Luckily you will not need to form a corporate entity like an LLC in order to create a solo 401(k), a 1099 shows you as being the sole proprietor which is all you’ll need.  As for the features that you should look for, it greatly depends on how you intend to use the account. Some people prioritize IRA rollovers, others put 401(k) loans as being necessary, while still others look for Roth contributions.  Luckily, you get to choose what’s most important to you and can make sure that your plan includes the features you really want. An important point to keep in mind is that some of these options may not be possible depending on where you choose to open the account.  TD Ameritrade offers different options than Fidelity which is different than Schwab, so make sure that you’re in the the right place. While a solo 401(k) is a great option, some people may be drawn to a SEP-IRA, also known as a Simple IRA.

SEP-IRA

The SEP or Simple has one major advantage over the solo 401(k) and that is that it’s very easy to set up and maintain.  It can be done online at most brokerages and mutual fund companies and can take as little as 5 minutes to fill out all the forms.  SEP’s allow you to contribute up to the same $55,000 limit, but because there’s no difference in employer/employee contribution like the with the solo 401(k) it’s a lot easier and requires far less paperwork.  This entire contribution up to the max is tax deductible as well. A SEP is a great option for those who are looking for somewhere to start saving money in a tax deductible account and don’t want any of the bells and whistles that come with the solo 401(k).  This is especially true for those who are starting their own practice and did so to build something that is uniquely their own and not to sift through pages and pages of financial documents. The downside of the SEP is that you don’t get any of those bells and whistles.  While it can take only 5 minutes to set up the account, it may be more advantageous to go through a more advanced plan and make sure you’re getting exactly what you want. While the SEP and solo 401(k) are the most common options, let’s take a look at some of the more unconventional approaches.  

Defined Benefit/Cash Balance Plan

These accounts are fairly uncommon among independent contractors but are still an option for those who want to put a bit more towards retirement.  Defined Benefit/Cash Balance plans greatly resemble an additional IRA but operate like a pension. These accounts are typically more expensive than the other options listed and require actuarial calculations to determine the contribution amounts, which means it’s very different than the SEP in terms of ease of management.  In fact, you will likely need an experienced firm to manage and run these types of accounts which also increases costs. The money in these accounts are typically invested less aggressively, but you are able to contribute more based on what the actuarial calculations determine. For those who are older and have less time in the plan, limits can be as much as $100,000/year in addition to other contributions for other plans you may be making.  These inflated contribution limits make these plans attractive for those who are a bit older and want to make sure they’re putting as much as possible into a retirement account. Last, but not least…

Taxable Investment Account

You can always invest in a taxable brokerage account for your retirement plans, which has both positives and negatives.  On the negative side, they were not designed to be retirement accounts so there are much fewer tax benefits built into the accounts, coupled with less asset protection options.  However, it does give you supreme flexibility with how the account is invested and can tailor the account to exactly how you want it to be run.

Any of these options can be viable for different people, and there are a number of other options that I didn’t get into.  So, for those striking out on their own whether they be doctors, NP’s, or anyone else, what are your thoughts about these accounts?  Have you used one of these before or are you planning to use one in the future? Is there a strategy or type of account that you’re using that isn’t listed?  I’d love to hear about what decisions you’ve made or if you need help making a decision, please send me an email and we can discuss it on a personal level.  

 

retirement for doctors