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Is a Roth IRA Right For Me?

Updated: Nov 30, 2020

The world loves a Roth IRA. Heck, I love a Roth IRA. Everyone's got to have one. Or convert to one. If you are self-employed, this is your go-to retirement account. No other choice exists. At least that's what I hear from many of my prospects and clients. Here's the thing though - it's not the only option people!

Read below for some account types and their primary attributes:

  1. The Holy Grail in your Mind: The Roth IRA

    1. You use after-tax dollars to fund the account, so any money you take out after retirement isn't taxed

    2. The maximum you can contribute in a year as of 2020 is $6,000 ($7,000 if you are over 50)

    3. There are income limits involved - if you make over $124,000 as a single person or $196,000 as a married couple, your ability to contribute decreases and eventually goes away.

  2. The Turbo-Charger: The SEP IRA

    1. You use pre-tax dollars to fund the account, so money you take out is taxable in retirement

    2. The maximum employers can contribute in a year as of 2020 is up to 25% of your compensation, with a maximum of $57,000. You choose whichever is less, 25% of your comp, or the $57,000

    3. Employees can still save $6,000 in an IRA (the current IRA maximum contribution)

    4. Contributions are tax-deductible and aren't required every year

    5. Generally speaking an "employer" funds this plan. If you are self-employed, that's you!

  3. The Play Nice Together: The Individual (or Solo) 401(k)

    1. You can use pre or post-tax dollars to fund the account. In other words, there are traditional and Roth options here, which will impact how dollars go in, and how they will eventually come out from a tax perspective

    2. The maximum employers can contribute in a year as of 2020 is up to 25% of your compensation, with a maximum of $57,000. You choose whichever is less, 25% of your comp, or the $57,000

    3. Employees can contribute $19,500 for themselves, just like the 401(k)s of large corporations

    4. Growth within the account is tax-deferred whether you establish a traditional or Roth 401(k)

    5. You can contribute as both an employer and an employee; but TOTAL annual savings can't exceed $57,000

    6. There are some administrative duties required to maintain an Individual 401(k) with the IRS

  4. The Starter Plan: The SIMPLE IRA

    1. You use pre-tax dollars to fund the account, so the money you take out after retirement isn't taxed.

    2. Employer contributions can match your contributions dollar for dollar up to 3% of your compensation, or employers can contribute 2% of your compensation up to certain limits.

    3. The maximum employee contribution in 2020 is $13,500, right in the middle between Roth IRAs and the other options

    4. You can contribute as an employer and deduct from payroll as an employee

Clear as Mud?

Woman deep in thought

Here are some questions to think through:

- How much do you want to save per year?

A Roth IRA is most administratively simple to open and contribute to, and most simple to understand. However, there are income limits, and the contribution limit is relatively low. Consider a Roth 401(k) if you really want that Roth benefit, but want to contribute more than the current maximum.

- To Roth or not to Roth?

This is a personal choice. The idea of taking money out in retirement tax-free might sound super attractive to some, others might not care. There are some technical ways to think about this, specifically do you believe your tax rate will be higher now or in the future? If you believe you will face a higher tax rate in the future, it might be better to swallow the tax pill now for the ability to take money out of your account tax-free in the future. In other words - go for a Roth option. If you are in the highest tax bracket now, but think that won't always be the case, it's better to make tax-deductible contributions to retirement accounts now. Yes, this is a complex choice, so now is a great time to put your CPA on speed-dial.

- Can you make these decisions on your own?

This whole self-employed retirement savings universe is complex, and I would argue that every person's situation is unique. The decisions you make around retirement savings directly impact your future, so it will help to contact a professional financial advisor. Remember to seek out a fiduciary, or someone required to act in your best interest.

- Do you plan on hiring employees?

If you plan on being self employed forever, then you can choose any of these options. If you think you want to expand, you should do some research on the complexities of these plans, and the administrative headache that occurs as you expand. Again, good idea to contact an expert here.

- Do you want to maximize your savings?

Go for the SEP IRA or Solo 401(k). The SEP is slightly less complex to start and run, but the Solo 401(k) has a Roth option, and allows for higher contributions.

- Does this post terrify you, and you just want to save a little for retirement, and why should you even be reading this?

Start with a Roth IRA. It's easy to open, and easy to contribute to.

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