July 20–You see many reports about how financially unprepared the average American is for life after working. If your savings need a jolt, one of your best moves during your career might be more work.
The Federal Reserve says that most investing Americans who save for retirement have a median account balance of little more than $103,000 — clearly insufficient to fund a retirement. A 65-year old with a retirement balance of $148,900 who withdraws 4% of that balance each year (a common withdrawal rate) pockets less than $500 a month. Even withSocial Security and perhaps a pension, you’d need to significantly scale back to not outlive your golden years’ savings.
How to boost your retirement accounts? Save more. Easier said than done: Many people simply retain no money after expenses, and even those with extra funds can only sock away so much. Your individual retirement accounts have contribution limits.
If you’re younger than 50 you can only contribute $5,500 per year into traditional or Roth IRA accounts (if you’re over 50 you can save an additional $1,000). Similarly, if under 50 you can contribute only $18,000 to your employer-sponsored 401(k) each year, plus an additional $6,000 if you’re over 50 (these 401(k) limits are in addition to matching money from your employer).
One potential way to bump up retirement balances: income from self-employment, ranging from consulting to driving for Uber. You report this pay on Internal Revenue Service Form 1099-MISC, “Miscellaneous Income.”
You can often earn 1099 income on your own schedule and create more money to save for retirement. More importantly, such income allows you access to unique retirement plans such as a solo 401(k), aka an independent, one-participant or family 401(k), or a simplified employee pension (SEP) IRA.
These plans enable you to save a tremendous amount in tax-advantaged retirement accounts — up to $53,000 in 2015 if you’re younger than 50, with additional catch-up contributions to a solo 401(k) if you’re 50 or older.
If you earn 1099 income, a Solo 401(k) enables you to contribute tax-deferred money to your retirement account as both an employee and an employer. As the employee, you can kick in the lesser of your earned income or $18,000, the 401k contribution limit ($24,000 if you’re older than 50). Additionally, as the employer you can contribute up to 25% of your income.
Your total contributions as both the employee and the employer can’t exceed $53,000 in this year ($59,000 if you’re 50 or older), according to IRS rules.
Let’s say you’re 55 and can’t afford to save any money from your primary job but you do make $30,000 of 1099 income. You can contribute $24,000 of this income to a Solo 401(k) as the employee and the additional $6,000 as the employer (as $6,000 is less than 25% of $30,000). You also save for retirement in a tax-deferred account — in turn preventing your tax bill for the year from increasing.
You do still need to pay the payroll tax, which consists of both the Social Security and the Medicare levies. As both the employer and the employee, you must pay the entire amount of both taxes (aka self-employment tax), which totals 15.3%, a generally higher rate that you pay on your regular income. You will also need to estimate and file your taxes every quarter on your 1099 income.
If you don’t look to save such a large amount, a SEP might work better. While you can’t make the $18,000 employee contribution, you can still make the employer contribution of 25% of your 1099 income.
A SEP, slightly simpler to create and maintain than a Solo 401(k), also allows you to make the full employee contribution to your primary employer’s retirement plan and still kick 25% of 1099 income contribution into your SEP.
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Lon Jefferies, CFP, MBA, is an investment advisor with the fee-only financial planning firm Net Worth Advisory Group in Sandy, Utah. You can find Lon on Twitter, LinkedIn and Google+. Contact him at (801) 566-0740 or firstname.lastname@example.org.
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