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Self-Employed? Here’s How Contributing to a Traditional IRA Can Benefit You
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A 2024 survey from SCORE, a nonprofit organization that provides guidance to small business owners, revealed that “34% of entrepreneurs do not have a retirement savings plan of their own.” While the reasons for this statistic vary, entrepreneurs and self-employed people need to know that they have options to save for retirement.
The good news is that you don’t have to use an employer-sponsored retirement plan like a 401(k) to save for retirement, as there are many options for those without an employer. This guide will explain how you can Traditional IRA (Individual Retirement Account) If you are self-employed.
Main points
- Self-employed people have retirement savings options outside of employer-sponsored plans.
- A traditional IRA is ideal for self-employed people with moderate incomes.
- Traditional IRAs are tax-advantaged and easy to administer.
- Understanding your retirement savings options as your income grows is key to achieving the best financial results.
How do I save for retirement if I’m self-employed?
As a self-employed person, you have five options for saving for retirement:
- Traditional IRA: Allows you to make pre-tax contributions that are tax-deferred until withdrawn in retirement.
- Roth IRA: You’ll make after-tax contributions with the benefit of tax-free growth and withdrawals.
- Solo 401(k): For those who are self-employed with no employees, this account allows you to contribute simultaneously as an employer and as an employee, potentially saving you even more each year.
- SEP IRA (Simplified Employee Pension): Perfect for small business owners or freelancers with few or no employees. The plan allows you to contribute a percentage of your income, which can be helpful as your business’s income increases because contributions are tax-deductible and can grow tax-deferred.
- SIMPLE IRA (Employee Individual Retirement Account Savings Incentive Matching Plan): Designed for small businesses and the self-employed, it allows employees and employers to contribute to retirement savings with simpler setup and lower cost than other plans like 401(k)s.
- defined benefit plan: A retirement plan that provides participants with fixed, predefined benefits. It’s ideal for high-income earners because it provides predictable retirement income and substantial tax deductions.
Each of the above savings tools has unique features and benefits that can make it better for one person or another depending on the individual’s financial needs and circumstances.
In this guide, we’ll focus on the traditional IRA and why it’s a viable retirement savings vehicle for self-employed people with moderate incomes.
What is a Traditional IRA?
Traditional IRA Yes tax benefits A retirement account that allows you to save money for retirement. The tax treatment of this type of savings vehicle (discussed in more detail below) makes it ideal for those who want to save for retirement but do not have an employer-sponsored plan.
tax treatment
The main appeal of a traditional IRA is the tax-saving element, which can reduce your tax liability as a self-employed individual and potential retiree. From a tax perspective, the retirement account is treated as follows:
- Tax-deductible donation: When you contribute to a traditional IRA, your contributions may be deducted from your taxable income for the year if you meet certain income requirements under the IRA. U.S. Internal Revenue Service (IRS).
- Tax-deferred growth: Investments in a Traditional IRA grow tax-deferred, so you don’t pay any dividends, interest, or capital gains taxes while the funds remain in the account. This allows your investment to compound over time without having to pay taxes every year, potentially leading to greater growth in the long term.
- Taxable Withdrawals: When you retire and eventually start withdrawing funds from a traditional IRA, the distributions will be taxed as ordinary income. If you are in a lower tax bracket during retirement, this may reduce your taxable income and overall tax liability.
Traditional IRA Contribution Limits
For tax years 2024 and 2025, the traditional IRA contribution limit for individuals under age 50 is $7,000 per year. Investors 50 years and older are eligible catch up contributionallowing them to contribute an additional $1,000 per year, bringing their total contribution limit to $8,000.
notes
Contribution limits generally change annually and apply to combined contributions to traditional IRAs and Roth IRAs.
Benefits of Traditional IRA
Before discussing the benefits of a traditional IRA, it is useful to examine some of the characteristics of other retirement accounts for self-employed individuals.
From here, we’ll explain why you might benefit more from a traditional IRA and what circumstances make it a better choice than some of the options listed below.
| retirement account | Contribution limit | tax treatment | Contribution income limit | Withdrawal tax | RMD | most suitable |
|---|---|---|---|---|---|---|
| Traditional IRA | $7,000/year ($8,000 for those over 50 years old) | Donations are tax deductible | No income limit | taxed as ordinary income | Yes | low- and middle-income individuals |
| Roth IRA | $7,000/year ($8,000 for those over 50 years old) | Donations are after-tax | Subject to modified adjusted gross income | Tax exemption if conditions are met | No (during the lifetime of the account holder) | Young or low-income investors |
| Irish Republican Army | Up to 25% of salary or $69,000 (2024)/$70,000 (2025) | Donations are tax deductible | No income limit | taxed as ordinary income | Yes | Small business owners and freelancers |
| Solo 401(k) | 2024: Total up to $69,000 per year ($75,600 over age 50) 2025: Total up to $70,000 (under 50)/$77,500 (50-59; 64 or older)/$81,250 (60-63 age) | Donations are tax deductible | No income limit | taxed as ordinary income | Yes | Self-employed person without employees |
| simple ira | $16,500/year (up to $20,000 if over 50 years old) | Donations are tax deductible | No income limit | taxed as ordinary income | Yes | Employees who work in or operate a small business |
| defined benefit plan | Calculated based on expected retirement benefits | Donations are tax deductible | No income limit | taxed as ordinary income | Yes | High-income, stable-income professionals targeting specific retirement benefits |
Depending on account requirements, contribution limits, and other IRS guidelines, the traditional IRA route is ideal for those who are just starting out or on a moderate income.
If your income increases or other aspects of your tax situation change, you may benefit from an account that allows you to contribute well in excess of the annual $7,000 to $8,000 limit. When the need arises, you can always open another retirement account so you can save more each year.
Require
income threshold
Although many people believe that there are income limits for opening and contributing to a traditional IRA, income limits only come into play in terms of how much you can contribute. deduct From your taxable income.
According to the IRS website, “If you (or your spouse, if you’re married) are covered by a retirement plan at work and your income exceeds a certain level, the deduction may be limited.” consult Latest IRS guidance Find deduction limits for those without an employer retirement plan, which is the case for most self-employed people.
income
To contribute to a traditional IRA, you must have income in the year you contribute to the account. Earned income includes wages, salaries, tips, bonuses, and other taxable income received from employment. Under certain circumstances, the spouse of an earning individual can contribute to his or her own IRA even without taxable compensation.
important
You can’t contribute more to a traditional IRA than your income for the year.
Contribution deadline
Contributions must be made by the tax filing deadline, usually April 15 of the following year. Any donation in excess of IRS allowable limits may be subject to a 6% tax excess contribution punish. To avoid this, keep track of your contributions and consult a tax professional when in doubt.
Required Minimum Distribution (RMD)
When you reach age 72 or 73, depending on your year of birth, you must begin taking annual minimum distributions from a Traditional IRA. Failure to withdraw RMDs can result in severe tax penalties, so planning for these withdrawals is important.
How to Join a Traditional IRA Plan
To join a traditional IRA plan, choose a financial institution that offers IRA accounts, such as a bank or brokerage firm. Then, complete the application according to the guidelines.
Once your application is approved, you can begin making contributions to a Traditional IRA, up to an annual limit set by the IRS. Remember, you must purchase investments such as stocks, bonds, mutual funds, and ETFs in your IRA because the contributions themselves are not investments.
If you are unsure about the investments you should choose for this account, consider consulting with a financial advisor to create an investment portfolio that meets your risk tolerance and retirement goals.
As a self-employed person, can I have multiple retirement accounts?
Yes, as a self-employed person, you can have multiple retirement accounts, including traditional IRAs and other accounts such as individual 401(k)s. See IRS guidance for annual contribution limits.
Since I’m self-employed, can I roll over my old 401(k) to an IRA?
Yes, you can roll over an old 401(k) into a traditional IRA when you are self-employed. Please contact your existing and new plan administrators for specific rollover steps so that the transfer is not considered an early withdrawal.
Are there income limits for Traditional IRAs?
There are no income limits for contributions to a Traditional IRA, but there are limitations on deducting these contributions. Each year, the IRS issues income guidelines that determine how much you can earn and still deduct your contributions from your taxes.
Can I contribute to an IRA if I lose my job?
Generally, you need to have income to contribute to an IRA, but there are exceptions. Married couples where only one of the spouses has an income can provide Spousal IRA Represent non-profit partners. Standard contribution limits apply, meaning couples filing jointly can contribute twice as much as a single filer.
When can you stop contributing to a Traditional IRA?
Beginning with the 2020 tax year, the IRS eliminated age restrictions for traditional and Roth IRAs. Therefore, as long as you have an income, you can contribute to a traditional IRA no matter your age.
bottom line
Even if you’re self-employed, there are many ways to save for retirement. Traditional IRAs are simple, flexible, and ideal for qualified individuals who don’t need to contribute more than a few thousand dollars a year.
If you’re just starting out or have a business model that results in lower revenue, this may be your situation. Even if you’re still deciding which retirement account type to choose, talk to a financial or tax advisor to optimize your retirement plan while maximizing contributions within allowable limits.
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