We often get the question asking us, “what’s the best retirement plan if I’m self-employed?” Well, that’s hard to say. There’s lots of plans out there, and the best one depends on your situation, right? Do you have employees or is it just you? How old are your employees? What are their salaries? So just to simplify, I’m just going to assume that – one person, self-employed, maybe their spouse is involved in the business, but that’s it, no employees. in that case, you might want to look into something called a solo 401(k) or an individual 401(k). It’s really simple to set up, not really a lot of cost to maintain, but it gives you a great amount of flexibility. As a self-employed person you’re the employee and the employer. And with a solo 401(k), you can make an employee contribution, as well as a profit sharing or a matching contribution on behalf of the business – again, because you’re also the employer. It’s straightforward, like I said, easy to set up, and gives you a pretty large amount of flexibility. If we’re talking about larger plans, and something that’s going to give you an even greater tax benefit, you might want to look into something called a defined benefit plan.
This is a little bit more costly to establish. There are some filing requirements, there are minimum annual funding requirements, but if you’re making a fair amount of money and you’re looking to put away really large sums of money, a defined benefit plan can be the way to go. You can put hundreds of thousands of dollars a year away into a plan like this. You could also pair that with a solo 401(k) to give yourself even greater flexibility. So like I said, while there’s not one end all be all plan that’s perfect or the right one, it’s going to depend on your actual situation.
There are many different factors that can reduce retirement income. The first may be fairly obvious, but it’s the effect of death. For two spouses when there’s a pension involved, the death of a spouse could mean the loss of a pension income. Now if there’s a survivor benefit, that income may continue, so it’s important to evaluate your options when making pension decisions. A lot of people use insurance to protect against this type of income loss. Another way death can reduce retirement income has to do with Social Security. When two spouses are receiving Social Security and one spouse passes there will be a loss of one of the benefits. Now, the surviving spouse will receive the higher of the two benefits, but there still will be some loss of income. The final way that death can reduce retirement income has to do with taxes. Moving from married filing jointly to now filing single can push the survivor into a higher income tax brackets. The reason for this is that the income thresholds for married filers is about twice what it is for single filers. This can have a major impact on the surviving spouse’s net after tax income in retirement.
Taxes in general is another area that a lot of people overlook when it comes to retirement income. The reality is that taxes will take much more from you than the market ever can. For instance, going back to 2008 during the Great Recession, the average portfolio might have declined 20 to 30 percent, assuming it was well diversified, of course. That might have taken a couple of years to recover, but taxes in retirement can easily cost anywhere from 30 to 40 percent. And that’s money that will never come back. So it’s really important to consider where your different sources of income are coming from in retirement. Would it all come from pensions, Social Security, IRAs, 401(k)s, sources that will be taxed at ordinary income rates? Or do you have good tax diversification where you can choose from pulling money from maybe a Roth IRA raise or non-qualified accounts and really get a lot of control over your taxes in retirement? And finally, inflation. Inflation is absolutely something that can reduce your income in retirement. And it does this by reducing the purchasing power of your dollar in retirement.
Inflation isn’t just something that happened in the past – things will continue to cost more in the future. So let’s look back 30 years. 30 years is about the average timeframe for most people in retirement. So in 1989, the average cost of a first class postage stamp was twenty five cents. Today that same stamp will cost you fifty five cents. Also in 1989 the average cost of a new car was $15,000. Today the price of a new car will set you back on average $37,000. So you need to look at how well your different sources of income will keep up with inflation during retirement. For help optimizing your retirement income, visit us at PureFinancial.com. .