Beth Franken is a writer, editor, and associate broker with Berkshire Hathaway HomeServices in Oak Park, Illinois.
A Menu of Real Estate Retirement Plans
Independent contractors have a wide-range of savings options. Here is a summary of four plans. Figure out which plan is best for you.
March 15, 2017
If you become an independent contractor in real estate after a prior career or two, it’s crucial, says Tad Cook at @Financial, to roll over a pre-existing employer-managed 401(k) into a Solo 401(k). “We don’t ever want you to take money out of a retirement account,” he says, meaning before you reach retirement age. “It’s not just the 10 percent penalty, or the tax liability you incur—it’s the loss of the compound interest.” If you take $10,000 out of a retirement fund at age 36, you’ve just lost what would’ve been $73,000 at age 70.
You may already know about traditional and Roth IRAs, which are for both employees and the self-employed but which have lower contribution caps.
Here are some other plans you may be less familiar with that are specifically designed for the self-employed.
To figure out what kind of fund is the best fit for you, ask yourself these questions:
Are you self-employed?
Do you have employees?
Will you contribute before or after taxes?
Will you want to borrow from your fund?
Solo 401(k)-Traditional (sometimes known by other names: Self-Employed 401(k); Individual 401(k); Solo(k); Single(k); Uni(k); One-participant(k):
The Solo 401(k) is similar to an employer-managed 401(k) but is for independent contractors without employees. The advantage of this plan is that you wear two hats—employer and employee—enabling you to make contributions in both categories. This generously increases the amount you can contribute—up to $18,000 as employee ($24,000 for those over 50) and an additional 25 percent of compensation as employer, for a maximum total of $53,000. Because the contributions are tax-deductible, you create tax savings and may even drop into a lower tax bracket. Your money grows tax-deferred, so is taxed when you withdraw it. You can add a spouse, but if you hire employees, you can no longer use this plan and must convert to a regular 401(k). One of the great advantages of a Solo 401(k) is that you are allowed to borrow from your savings and then pay yourself back, with interest. When opening a plan, pay attention to the fees and shop around.
Roth Solo 401(k): For the Roth version, you put in after-tax dollars and your contribution is not tax-deductible. However, your money grows tax-free, meaning it is not taxed upon withdrawal. Like the traditional Solo 401(k)s, you can borrow from yourself but must pay yourself back.
Find out what people are planning at various stages of their real estate careers.
SEP IRA: SEP is an acronym for Simplified Employee Pension, which is for a small-business owner, independent contractor, or anyone with freelance income. An advantage of a SEP IRA over a Traditional IRA is the higher contribution limit; you can contribute as much as 25 percent of your net income (up to $53,000 in 2016). Your contribution can differ from year to year, depending on how profitable your year was. Importantly, your contribution is tax-deductible. Your funds are taxed later, at withdrawal. You can open a SEP IRA at any bank or brokerage firm, and the fees are very low (as low as $10). Unlike a Solo 401(k), you cannot borrow from your SEP IRA.
SIMPLE IRA (Savings Incentive Match Plan for Employees): A good choice for brokers with employees. You must match your employees’ contributions, up to 3 percent of pay, and this is regardless of your cash flow. Contributions are capped at $12,500 (or $15,500 if you are over 50), and there is a stiff penalty (25 percent) for early withdrawal. There are no borrowing provisions, but the account is easy and inexpensive to set up.
Updated: November 24, 2021