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Updated Aug 10, 2023

How the Self-Employed Can Make Roth IRA Contributions

If you're self-employed, a Roth IRA is one of the retirement savings tools you need in your arsenal.

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Dock Treece, Senior Analyst & Expert on Business Operations
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More than 40% of the U.S. workforce comprises people in nontraditional jobs: They are freelancers, business owners, and independent contractors, often cobbling together a paycheck from several sources.

A Roth IRA is one of the essential retirement saving tools for self-employed people. It’s hard enough for traditionally employed people to save for retirement, and harder still for the self-employed.

What is a Roth IRA?

A Roth IRA is a type of retirement account that allows individuals to contribute after-tax dollars to an account. Their money then grows tax-free, and account holders can access funds in their account once they turn 59.5, without paying any taxes on their distributions.

In a nutshell, Roth IRAs are particularly good for people who expect to be paying a fairly high tax rate when they are retired. That includes a lot of self-employed people, like small business owners who might cash out of their companies later in life.

Did You Know?Did you know
The rise in self-employment is one of the factors behind the decline in workplace retirement coverage.

Benefits of a Roth IRA

Traditional plans for retirement savings allow people to deduct contributions from their taxes but require them to pay taxes on withdrawals. Roth plans require you to contribute after-tax money but enable you to deduct withdrawals you make in retirement.

Editor’s note: Looking for the right employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

But be aware that contribution limits for tax-qualified accounts like IRAs are not considered separately. If you contribute money to a Roth IRA, you can’t contribute the maximum to other types of retirement accounts as well.

Also, not everyone is allowed to use a Roth IRA. Your modified adjusted gross income must be under certain limits, which vary from year to year and based on your tax filing status.

So, while Roth IRAs offer both tax-free growth and tax-free distributions, they also have several drawbacks:

  • Contributions are not tax deductible.
  • You can only contribute if your income is under a certain threshold.
  • Roth IRA contribution limits are not considered separately from other IRAs.
TipBottom line
If you are considering a Roth IRA, also look into a SEP IRA or another kind of retirement plans specifically designed for self-employed people.

What is the difference between a Roth and SEP IRA?

The biggest difference between a SEP (Simplified Employee Pension) and Roth IRA is that the SEP has much higher contribution limits. A SEP IRA allows you to deposit 25% of your income, up to $58,000 a year, in 2021.

SEPs are taxed as regular income during retirement, unlike Roths. However, you can make pretax contributions to a SEP. Essentially, a SEP allows the taxes you owe on it to be deferred until retirement. With a Roth, you pay taxes on the income upfront.

This year, you can contribute $6,000 to a Roth after you’ve made your SEP contribution. However, you also have to fall under the income limit for Roths. If you are married, you must make less than $183,000.

The ability to contribute to both a SEP and a Roth is a boon to the self-employed that makes it a little bit easier to save. The rules are detailed on the IRS website.

4 things to know if you want to open a Roth IRA

1. You need a brokerage company to hold the account for you.

Look for a brokerage company with good customer service and no fees on the account. All of the big brokerage houses – Fidelity, Vanguard and Schwab – offer Roth IRAs, as do smaller brokerages. Look for a brokerage that offers to hold the account for you without charging a fee. You might also find it convenient to keep your Roth IRA at the same company that offers SEP or other kinds of IRAs.

Because you’re self-employed, look for a brokerage house that employs advisors, like Merrill Lynch, or a discount brokerage, like E-Trade, that offers good phone support and advice on picking investments. You could also hire an independent investment advisor or financial planner.

2. When it comes to investing for retirement, you should keep it simple and cheap.

One of the easiest options is a high-quality target date fund, which will automatically match your investment mix to your age as the years go by. You can also ask your brokerage to buy a selection of mutual funds or exchange-traded funds (ETFs). The classic approach is a mixture of stock and bond funds, with the proportion of bond funds rising as you age.

One of the factors you can best control is fees. Look for low fees on whatever investment you pick. You should be able to find low-fee, broad-based funds for your Roth IRA for an expense ratio of less than 0.25% a year. Remember, any gains are growing tax-free; that’s one of the best things about a Roth IRA.

3. You’re better off making automatic, periodic contributions.

Because you’re self-employed, you don’t have the crutch of automated deductions and escalations as traditional employees do. Set up monthly automatic deductions from your bank account to your Roth IRA. Small, regular contributions over time can help your returns.

4. It’s important to look at all of your retirement accounts at once to make sure you’re diversified.

If you are self-employed and don’t have a financial advisor, the only person to do this is you. So, make sure you’ve diversified into stock and bond funds, perhaps international stock and bond funds too.

Why is it crucial to look at all your plans at once? If you’re 90% in stock mutual funds in your SEP plan, which has $100,000, and 90% in bond funds in your Roth, which is only $25,000, you aren’t properly diversified between stocks and bonds. Look at your total and then decide how you want to invest.

Another retirement savings option: A 401(k) plan

A 401(k) is another option for self-employed workers saving for retirement. You can salary-defer up to $19,500 into a 401(k) plan. If you are over 50, you can add another $6,500. You can deposit up to 25% of your net earnings for self-employment as well, up to a total of $57,000. This includes salary-deferred payments.

Changes in the workplace are placing the burden on you to save for retirement, but the tax code gives you the tools you need to succeed. Start now.

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Dock Treece, Senior Analyst & Expert on Business Operations
Dock David Treece is a respected finance expert known for his thorough exploration of business financial matters, with a focus on Small Business Administration (SBA) loans and alternative lending. He currently serves as the senior vice president of marketing at BNY Mellon, having previously held the role of editorial manager at Dotdash. Drawing from over 17 years of experience, Treece has worn various hats, including financial advisor, registered investment advisor and a key position on the FINRA Small Firm Advisory Board. In addition to his corporate roles, Treece's entrepreneurial background adds depth to his understanding of the challenges and opportunities small business owners face. As a co-founder and manager of a small business, he offers firsthand insights into the tools and tactics necessary for success in the ever-changing entrepreneurial landscape.
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