Retirement isn’t what it used to be. Today’s retiree is as likely to be running a small business as he is to be playing golf. According to the Kauffman Index of Startup Activity, Americans between ages 55 and 64 were responsible for 25 percent of the new businesses formed in 2015.
While some of those founders have long been entrepreneurs, others are running small businesses for the first time, whether it’s playing in a bluegrass band, selling goods online or driving for Uber.
One advantage to opening a business in retirement, of course, is the additional income. Owning a business in retirement can bring tax breaks and opportunities to bolster your retirement nest egg.
“It’s really a great thing … from a number of points of view,” says Mari Adam, a financial advisor in Boca Raton, Florida. “When you have some type of business that you’re running, you’re gaining the ability to deduct all kinds of expenses.”
[See: The Best Cities for Retirement Jobs.]
Tax deductions for small business are basically the same for taxpayers of any age. You can deduct the cost of supplies, equipment, business meals and travel, contract employees and any other legitimate expense incurred. If your business is based at home, you can also take a home office deduction.
Once you’ve reached your full retirement age — 66 for those born between 1943 and 1954, rising to 67 for those born in 1960 or later — you can collect your full Social Security payment regardless of how much you earn in a side business. If you start collecting Social Security early, your benefits will be reduced $1 for every $2 you earn over the limit ($15,720 in 2016).
“It’s a great opportunity to supplement your retirement savings,” Adam says. If you earn enough in your side business, you may be able to delay taking Social Security, which increases your monthly benefit amount until you reach age 70, or delay dipping into your retirement funds.
Driving part time for Uber or Lyft or selling jewelry may net a retiree only an additional $10,000 a year. But Adam says even that amount can make a significant impact. “For every $10,000 you’re able to earn, it lets you not take that out of a portfolio,” she says. To take $10,000 safely out of retirement savings each year, Adams says, you would need an additional $250,000 in your nest egg.
One great advantage of working in retirement, even after you’ve started collecting Social Security, is that you can continue to add to your retirement savings. You can contribute to a regular IRA until you’re 70 1/2 and you can contribute to a Roth IRA indefinitely. As a self-employed person, you also can contribute significantly more than $6,500 a year to an Simplified Employee Pension plan or Solo 401(k).
“It’s going to give you the ability to save lots of money toward your retirement and then deduct it,” Adam says. “To do all those contributions, you have to have earned income.”
For example, if you earn enough money, you can contribute up to $59,000 to a Solo 401(k), as long as you are over 50 — deferring all taxes on that income until you withdraw it. You can also contribute past age 70 1/2, though you will need to take required minimum distributions from your retirement accounts after that point.
“The sole-proprietor 401(k) is absolutely awesome for someone who is retired but has a business,” says John Lindsey, president and CEO of Lindsey & Lindsey Wealth Management in Westlake Village, California. “That money is deducted straight from the top,” meaning it comes from pretax funds, just as it does with a 401(k) provided by an employer, and is not included in your taxable income. If you employ your spouse, he or she also can participate in the Solo 401(k).
Self-employment also gives you the opportunity to deduct health insurance premiums and long-term care insurance premiums, as long as your business makes a profit.
“If you’re self-employed, you get to deduct your health insurance whether or not you itemize deductions,” says Bob Charron, the partner in charge of tax practice at Friedman LLP in New York.
If you’re living solely on Social Security, earning additional money may mean that you have to pay income tax. For most older workers, the additional money earned more than compensates for any extra tax burden, especially once deductions are taken.
Anyone who owns a business should consult with an accountant, financial advisor or tax professional about available deductions and how those deductions fit in with their personal retirement savings and spending plan. And keep in mind that rules on some deductions vary by the type of business structure.
“You can cut your taxes significantly if you’ve planned your business properly,” Lindsey says.
[See: How to Reduce Your Tax Bill by Saving for Retirement.]
It’s important that you treat your business as a business; you can’t deduct expenses for a hobby. While the Internal Revenue Service doesn’t require your business to be profitable (and losses can be written off against other income), it does require you to attempt to make money. In general, you’re expected to make a profit in three of the last five tax years to qualify as a business.
“If it’s a hobby, the IRS gets very upset at that,” Charron says.
Here are six reasons — beyond your earnings — that it can pay to be self-employed in retirement:
You can deduct health insurance and long-term care premiums. If you’re self-employed, you can deduct the health insurance premiums for you, your spouse and your dependents, as well as long-term care insurance premiums for you and your spouse, subject to limits.
You can delay taking Social Security. You monthly benefit is increased about 8 percent every year you wait to collect Social Security, up to age 70. If your side hustle yields enough money that you can avoid holding off on claiming Social Security, that’s equivalent to an 8 percent return on investments.
You can deduct some expenses you would have anyway. Those can include computer equipment, instruments if you’re a musician, tools and materials if you sell crafts and other items you need for your side venture. Travel to gigs or art shows or trips to professional conferences also are deductible, as are business meals and entertainment.
You can continue adding to your retirement accounts. You have the option of saving significant amounts of money in an SEP-IRA or Solo 401(k) pretax, only paying tax when you withdraw it. Or you can contribute after-tax money to a Roth IRA.
You can delay withdrawing from your retirement accounts. If you don’t withdraw money to live on from your retirement accounts, those accounts will continue to grow. The general rule of thumb is retirees can safely withdraw 4 percent from their retirement savings each year. But if you can withdraw a lower amount — or nothing at all — while you work, you’ll be in better financial shape down the road.
[See: 50 Affordable Places to Buy a Retirement Home in 2016.]
You can shift assets to family by paying your children or grandchildren. You can pay your grandchildren under 18 to do tech support, file papers, stuff envelopes or anything they’re capable of doing and deduct the money paid for their services. Each child can earn up to $6,300 tax-free, and even more if the child has an IRA.
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How to Use Self-Employment to Cut Your Taxes in Retirement originally appeared on usnews.com
