Defeating Retirement Planning Challenges When You're Self-Employed

An estimated 15 million people, or roughly 10 percent of the U.S. workforce, were self-employed in 2015. According to a TD Ameritrade survey, 55 percent of them are falling behind when it comes to saving for retirement.

Without an employer-sponsored plan to fall back on, self-employed people must be more resourceful about ensuring they hit their retirement goals. The path, however, is often littered with obstacles that the typical retirement saver may not encounter. Learning how to outmaneuver them is essential for creating a secure financial future.

Irregular income makes saving problematic. One of the downsides of self-employment is that you can't always count on a steady paycheck. In the TD Ameritrade survey, 48 percent of self-employed people said an inability to predict their income was a major barrier to saving and investing more effectively.

Dave Lafferty, a certified financial planner and senior financial advisor at Philadelphia-based Wescott Financial Advisory Group, says the first task for business owners is finding the money to invest. "Once you're committed to building a retirement plan and growing wealth outside of your business, it's time to start digging into specifics," he says.

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Lafferty says business owners should look at profitability year over year and whether there are any cyclical income trends that tend to repeat. He also advises looking at how you pay yourself and what you're doing with any remaining profits the business generates. Paying attention to these details can provide clues as to how to establish a regular pattern of investing for retirement.

Lou Cannataro, a partner at Cannataro Park Avenue Financial in New York, says creating consistency in your savings plan is essential for business owners. "Not knowing what you're going to make each month is quite often the biggest concern when you're self-employed," he says.

Cannataro says business owners should use their average monthly income to create a baseline for determining a minimum amount they can afford to contribute to a retirement plan and make those contributions automatic.

Automating your investments means you're still paying yourself first, even in lower income years. In years when income swings up, you have the option of making additional contributions into the plan.

Making sense of retirement plan choices can be overwhelming. Being self-employed doesn't mean you have fewer options in deciding where to invest for retirement. In fact, the opposite is true. The challenge lies in deciding which one to choose.

Mike Frost, senior wealth planning strategist at Wells Fargo Private Bank in McLean, Virginia, offers advice for finding the right plan.

"Self-employed savers must balance the competing considerations of plan flexibility and making the largest contribution possible," Frost says.

Frost says flexibility is critical because it's impossible to predict with absolute certainty the amount of revenue a business may generate over the course of a year. The best retirement plan for someone who's self-employed, says Frost, is the plan that provides that latest possible deadline for making contributions and the highest contribution limit for their business structure.

Drew Horter, president and chief investment strategist at Cincinnati-based Horter Investment Management, points to three options self-employed individuals should consider: a solo 401(k), a SEP IRA and a SIMPLE IRA.

"With a solo 401(k) or SEP IRA, business owners can contribute up to $54,000 or 25 percent of compensation for 2017, whichever is less," Horter says, while self-employed savers can contribute up to $12,500 to a SIMPLE IRA. All three plans allow additional catch-up contributions if you're 50 or older.

Those limits are more generous than the annual contribution limit for a traditional or Roth IRA, giving you more opportunity to save cash for retirement. For 2017, the contribution limit to those plans is $5,500, with an additional $1,000 allowed for catch-up contributions.

Lafferty offers yet another option for those who have highly profitable businesses.

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"One vehicle our advisors have recommended for business owners is the cash balance pension plan, which combines features of defined benefit plans and defined contribution plans while allowing for significant contributions," Lafferty says.

Contributions to these plans are calculated as a percentage of your annual compensation. Depending on your earnings from self-employment, it's possible to contribute well over $100,000 per year into one of these plans. The trade-off is that a cash balance pension plan can be expensive to set up and maintain.

Cannataro reminds savers to do their research before making a final decision.

"Self-employed individuals need to consider all the retirement plan options available to them and which fits best based on their income, age and whether their business has employees," Cannataro says. He recommends that business owners who are still stumped about which plan to choose work with a financial advisor to determine which plan is appropriate.

Managing tax liability is tricky. Being self-employed means managing the burden of making sure you're paying enough in taxes each year. Taking advantage of tax breaks can reduce your tax bill but it could also hinder your ability to save for retirement.

Frost reminds self-employed savers that contributions to qualified retirement plans are tax-deductible and that health insurance premiums can be used to reduce adjusted gross income. The trick, he says, is to be aware that as you lower your taxable income, you may also be shrinking the amount you can contribute to a retirement plan since the contribution limit is based on your self-employment earnings.

Charles Scott, a financial advisor at Pelleton Capital Management in Scottsdale, Arizona, says self-employed individuals should look to their health insurance plan as an alternate path for saving.

"My favorite tax break for the self-employed is a health savings account," Scott says. "It's triple tax-advantaged because you fund it with pre-tax dollars, it grows tax-free and withdrawals are tax-free when used to pay for qualified medical expenses."

You may have access to an HSA if you're enrolled in a high-deductible health plan. In a pinch, an HSA can double as a source of income in retirement. After age 65, you can with make non-medical withdrawals penalty-free. You'll just owe regular income tax on the distributions. That can be helpful if your contributions to a solo 401(k), SEP or SIMPLE plan were limited because deductions lowered your taxable income significantly.

Lafferty offers a final tax tip to self-employed business owners: Report all of your income accurately.

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"Future Social Security retirement benefits are determined by how much income you earned," Lafferty says. If you plan to supplement your retirement savings with Social Security, it's vital that you get credit for every penny you've earned from self-employment during your working years.

Rebecca Lake is a freelance Investing & Retirement reporter at U.S. News & World Report. She's been reporting on personal finance, investing and small business for nearly a decade and her work has been featured on The Huffington Post, Business Insider, CBS News and Investopedia. You can connect with her on LinkedIn and Twitter or email her at rlake0836@gmail.com.