It’s becoming more difficult every day to rely on other people to take care of your financial health as you get older. Whether it’s corporate shenanigans or the implosion of Social
Security, it seems like there’s always a reason to worry.
When you’re working for someone else – if you’re fortunate – you have a company-matched 401K and – if you’re really fortunate – maybe even a fully funded pension plan. When you’re self-employed, though, saving for retirement is completely your responsibility. And unless you want to still be working when you’re 89, it’s a good idea to start saving now.
Fortunately, at least for right now, the government makes it easy and tax free to build up your personal retirement account.
IRA or 401k?
A 401K is a special type of retirement fund set up and administered through your employer. Some companies offer to match a percentage of every dollar you contribute, making this a nice, pre-tax perk to grow your savings. An individual 401k can be set up for self-employed individuals under certain circumstances.
Individual Retirement Accounts (IRAs) are set up with the help of a bank or financial planner, and are also not taxed. So, if you’re paying 30% of your net income to the IRS, you can save 30 cents on every dollar you contribute to an IRA.
There are limits on how much you can invest in a retirement account. For individual 401Ks, the maximum you can save pre-tax is $17,000. For IRAs, it’s $5,000 annually.
Before you start saving, though, remember that this tax savings comes with a catch: You can’t touch the money until you’re 65, without paying the income tax AND added penalties. Plus, you’ll have to pay income tax on that money when you retire. So don’t look at these retirement savings options as a tax shelter. They’re not.
Are retirement savings accounts a sound investment?
Retirement savings accounts definitely have one leg up on stashing your money in the bank: the potential to earn high interest rate returns. Since you have the flexibility to divide your IRA funds up among various investments, you can potentially see returns as high as 12 or 14%. That’s far more than the maximum of 1% your savings account is probably offering right now.
But, being realistic, your retirement funds are being invested in stocks and bonds, so there’s no guarantee that they will earn money. As a matter of fact, anyone who was close to retirement age when the economy took a downturn can tell you how secure they felt. Many people saw their IRAs and 401k’s disappear before their eyes.
But if you’re a small business owner hoping to put some money aside for retirement and save money on taxes at the same time, an IRA or individual 401K is ideal. They’re easy to set up and inexpensive, plus they give you the freedom to invest your money in high-earning stocks or to choose bonds, based on your level of risk aversion.