If you’re one of the growing number of independent contractors, retirement planning can sometimes seem daunting given the lack of access to a traditional retirement account like a 401(k). Fortunately, there are plenty of tax-advantaged options available for 1099 workers.
As an independent contractor, a team of advisors can make a big difference to your bottom line in retirement. While doing it yourself is possible, good tax and financial professionals can easily justify their fees due to the savings that come from their advice and expertise. There are many resources now available that enable all contractors to easily get quality financial advice, even with limited funds. Make sure that your advisors are working together to give you an accurate picture.
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Your role is to successfully kick off this planning. You should come to the table with the information to create a cash-flow statement. This includes the details for all inflows and accounts payable, as well as outflows such as rent, utilities and insurance. With just a few months of data, you will quickly be able to ascertain key fluctuations in income, as well as to find periods when money is easier to allocate for the future. Your advisors will be able to determine qualifications for qualified retirement plans, where significant tax savings can occur.
The IRS has strict limits on qualifications for these retirement plans. 1099 workers may not be eligible or the allowable contribution may be reduced if they also have W-2 employment or a spouse that has access to a retirement plan. The tax code changes frequently, and only a professional tax advisor can give you specific tax advice. At this time, artificial intelligence is not always able to keep up with the pace of tax changes, so this is another important reason to have a great team assisting you.
Additionally, the SECURE 2.0 Act passed by Congress has numerous new provisions that are coming to bear in 2024, including new penalty-free withdrawals under circumstances such as being the victim of domestic violence, a first-time homebuyer, certified by a physician as being terminally ill or located in a federal disaster area. Qualifying birth or adoption expenses can also receive penalty-free access. These provisions inject an important source of liquidity to a participant who has incurred a major life event or experienced an unforeseen emergency, but they should be reviewed carefully.
Overall, retirement plan options for 1099 workers have grown significantly, and each has its distinct advantages and limitations. Once you are in position to set aside funds, here is a list of popular options:
— Traditional individual retirement account, or IRA.
— Roth IRA.
— Simplified employee pension (SEP) IRA.
— Savings incentive match plan (SIMPLE) IRA.
— Solo 401(k).
— Health savings account (HSA).
— Defined benefit plan.
Traditional IRA
Anyone can establish a traditional IRA. Contributions to traditional IRAs are tax deductible. So, if you put the $7,000 limit for 2024 into an IRA ($8,000 for those age 50 or older), your taxable income for the year decreases by that amount as long as you don’t have an employer-sponsored retirement plan. If you are married and filing jointly with a spouse who has an employer-sponsored plan, you can still make the full deduction if your modified adjusted gross income doesn’t exceed $230,000.
Funds grow tax-deferred, and retirement distributions will be taxed at your ordinary income tax rate for that year. Additionally, distributions made before age 59 1/2 will be subject to a penalty. Traditional IRAs have required minimum distributions (RMDs) beginning at age 73. Even if you do not need the money, you must take a distribution or incur a substantial penalty. RMDs are calculated using both the person’s life expectancy and the IRA account size.
Roth IRA
This account is for singles whose 2024 modified adjusted gross income is less than $161,000; married couples who file jointly can make at least a partial contribution if their income is under $240,000. While no tax deduction is associated with a Roth IRA, its high appeal to self-employed participants is that earnings will grow tax-deferred and retirement income from the account will be tax-free. In 2024, if you are less than 50 years old, the maximum contribution is $7,000. Older investors are eligible for an additional catch-up contribution of $1,000, for a total of $8,000.
Under the new provisions in the SECURE 2.0 Act, you may be able to contribute to your Roth IRA with rollover 529 plan assets. This rollover option is not available for traditional IRAs.
Simplified Employee Pension (SEP) IRA
A SEP IRA can be set up for both the employer and the employees of a business to provide a valuable employee benefit. Employees cannot contribute their own money, but their withdrawals are still taxed as ordinary income. The maximum allowed contribution for 2024 is $69,000 or 25% of compensation, whichever is less.
While SEP plans are easy to set up and administer, owners must contribute the same percentage to all their employees as they contribute to their own plan. Like traditional IRAs, withdrawals are taxed as ordinary income and subject to both early withdrawal and RMD rules.
Savings Incentive Match Plan (SIMPLE) IRA
SIMPLE plans vary from SEP plans in that they will allow a business owner’s employees to make contributions to their accounts, alongside employer contributions. Contributions are tax deductible, and this can result in a lower tax bracket overall. Business owners love SIMPLEs because they can offer a desirable employee benefit very inexpensively without the need for plan administration services. Retirement income is taxed like a traditional IRA. The SIMPLE IRA employee contribution limit is $16,000 in 2024. There is also a $3,500 catch-up contribution available to workers who are age 50 or older.
Solo 401(k)
This plan, called the “One Participant 401(k)” by the IRS, allows solo business owners to enjoy the benefits of a corporate 401(k). The plans are reserved exclusively for the owner (and their spouse, if applicable) who has no employees and earns a maximum of $345,000. In 2024, you can contribute a maximum of $69,000, and an additional catch-up contribution of $7,500 is available to those 50 or older. Deductibility and income taxes upon distribution depend on whether the business owner selects a traditional plan or the Roth option. A plan administrator is needed, and those fees can add as much as $2,000 to the cost, depending on the provider.
In these plans, the business owner is considered both as the employer and the employee for contribution purposes. These limits apply within the overall maximum contribution:
— Employee contributions are to a maximum of $23,000 in 2024, or 100% of compensation, whichever is less. A catch-up contribution of $7,500 is available to those 50 and older.
— Employer contributions are made as an additional profit-sharing contribution. This contribution is 25% of either compensation or net self-employment income. The latter is calculated as net profit less half of self-employment tax and the plan contribution made as an employee.
Health Savings Account (HSA)
HSAs are the unsung heroes for the self-employed because they not only enable one to save for retirement, but they also allow the business owner to accumulate funds on a tax-advantaged basis to pay for qualified health, dental, vision and pharmacy expenses. An HSA is established with a qualified high-deductible health plan. There are no taxes on the contributions, the account growth or any distributions that pay for qualified expenses not reimbursed by the health plan provider. All contributions are vested and assets are carried over at the end of the year.
An HSA cannot be set up if you have multiple health care plans or you are enrolled in Medicare, or if you can be claimed as an dependent on another person’s tax return. In 2024, the maximum HSA contribution is $4,150 for an individual and $8,300 for a family. HSAs are also eligible for a $1,000 catch-up contribution, although the qualifying age is a bit higher, at 55 or older.
Defined Benefit Plan
These pension plans are among the oldest in the tax code, but they fluctuate in and out of favor depending on the economy. With inflation keeping pressure on interest rates, they are coming back in vogue.
Defined benefit plans provide guaranteed income in retirement. Higher contribution limits can also provide significant tax deductions, especially if an older business owner has the capability to make consistent contributions for a set period.
These plans can be complex, making them expensive to administer. Additionally, not all businesses are good candidates for this type of plan. A financial advisor is invaluable to determine if this is a viable option for a business and to recommend plan administration services.
The Takeaway
There are now more retirement options for 1099 workers than ever, increasing the complexity of making the best decision for you and your business or side gig. A great CPA, working alongside your financial advisor, can quickly help you select the best option. Additionally, they can combine these plans, such as crafting a backdoor Roth IRA, to generate additional tax savings that will allow you to put even more money away for retirement. Most importantly, they can also make sure that you truly qualify for a particular option and take your distributions properly, given all the IRS boxes that have to be checked.
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Retirement Plan Options for 1099 Employees originally appeared on usnews.com
