Self-employed professionals enjoy the flexibility, control, and creativity an independent career offers, but the challenge and uncertainty of planning for retirement is a common concern. At a traditional job, you have the benefit of built-in retirement options, but this field can be more difficult to navigate on your own.
Fortunately, there are a number of solutions available. The right one for you will depend on a number of factors including your personal goals and income level, which you can discuss with a financial advisor. In this series, we’ll explore the retirement options available to independent contractors and provide you with what you need to know for a financially secure future.
Think of a defined benefit plan like a pension plan for independent professional employers. While this retirement option is more costly to implement and maintain, it does allow for significantly larger contributions than a solo 401(k) or an SEP IRA.
When you set up a defined benefit plan, you’ll work with an actuary to determine your retirement payout. Based on this decision, along with other factors such as age and expected returns on plan investments, the actuary will calculate your monthly or annual contributions. Defined benefit plans can be complicated, but if you’re a high-contributor looking to maximize your retirement income, this plan may be right for you.
A defined benefit plan has high contribution limits; earnings grow tax deferred and are taxable when withdrawn at retirement. Contributions are also tax deductible as a business expense (within IRS limits), which helps to reduce your taxable income.
Defined benefit plans can be combined with other retirement options such as a solo 401(k), or an SEP IRA, which increases the amount you can save for retirement each year. Lastly, this plan can help provide risk mitigation for your future finances because creditors cannot seize defined benefit plan assets. This means that even if your business is the target of a lawsuit, your retirement assets are safe—even in a worse case scenario.
Defined benefit plans can be complicated to set up and costly to run. Plan on paying startup fees, administrative requirements including annual actuarial calculations, and filing fees for IRS Form 5500. You’ll also have to commit to funding your plan at a minimum level each year in order to meet payout requirements, regardless of how your business fares. If your small business has employees, you are required to offer the plan to them, which can get expensive as well. Defined benefit plans can take more than three months to set up, so it’s important to take this time into account as well. As with most retirement plans, early withdrawals are subject to penalties.
Defined benefit plans are best for independent professionals with high, stable incomes who want to quickly save for retirement and who have few or no employees. The ideal defined benefit plan candidate is able to make annual contributions of $80,000 or more for at least five years.
Example 1: Small business owner
Chelsea, age 60, owns a small business and her average annual income is $400,000. She plans to retire when she is 70, and ultimately wants to set aside $1 million using a defined benefit plan. Working with an actuary, Chelsea determines that her monthly contributions will be $7,500, or $90,000 per year, to meet her goal.
To learn more about retirement options for independent professionals, contact us today.
This content from MBO Partners does not constitute legal or financial advice.
Solo 401(k) for self-employed professionals: everything you need to know about contribution limits, advantages, and disadvantages.
SEP IRA for self-employed professionals: everything you need to know about SEP IRA contribution limits, advantages, and disadvantages.