This week marks the fifth annual Women’s Money® Week and today is International Women’s Day. Most people are aware of the wage gap between men and women, but the relationship between women and money is more than just that. Women are grossly underserved in the financial world and this is one of the reasons why I founded Brightwater Financial. According to Women’s Money®:
2/3rds of household breadwinners and co-breadwinners are women/moms. Our country’s economic future relies on the financial stability and success of household breadwinners. Did you know that if women were paid the same as men for the same job, we would reduce poverty in America by 50%!
Reducing poverty by 50% is huge! Unfortunately, the 2010-2011 Financial Experience & Behaviors Among Women research study by Prudential found that “fewer than two in 10 women feel “very prepared” to make wise financial decisions. Half indicate that they “need some help,” and one-third feels that they “need a lot of help”.”
When I asked a group of local working moms, many who are self-employed, about their money and financial planning questions, the very first question was around saving for retirement:
When I left my corporate position to become self-employed, I sacrificed contributing to a [company-sponsored] 401(k). I know I could pursue a self-employed 401(k), but I have no idea how that works. I don’t get matching now and it makes me wonder if it’s even worth it. My husband is saving to his. Do I need to resume, too? So, my question would be – do you recommend any options? Is there a bare minimum someone should save?
How Much to Save
Since there are no loans for retirement, let’s start with how much to save. When creating a budget, the “50/20/30 Plan” keeps things fairly simple: 50% Needs, 20% Savings, and 30% Wants. Your bare bones personal and business budgets are the 50% Needs. On the personal side, these are your nonnegotiable expenses: rent/mortgage, utilities, insurance, groceries, etc. On the business side, this might include website hosting and registration fees, service fees when invoicing a client, computer software, or legal and professional fees. The 20% includes saving, retirement, and investing goals. The last 30% for Wants includes hobbies, eating out, and other lifestyle choices. If you have debt payments, include those in the “Savings” bucket.
One quick rule of thumb is that you need to invest and save 25 times your annual expenses to cover retirement. Once you’ve calculated your 50/20/30, compare your current monthly savings to this goal to ensure you’re saving and investing enough. The spreadsheet in this blog post will help you do the math.
If there’s a disconnect between your target and actual savings, how will you bridge the gap? As an entrepreneur, should you be charging more? If so, think about ways you can you add more value to your services. Can you take some classes to improve your skills? If you need to take on additional projects, is it possible to outsource some of the administrative tasks so you can spend more hours performing revenue generating work? Or will you need to decrease some of your expenses?
Where to Save
Traditional or Roth IRA
One way an individual with earned income can start saving for retirement is by contributing to a traditional or Roth IRA. Individuals have until April 18, 2016 (usually it’s April 15) to make a contribution for the 2015 tax year. For 2015, individuals can contribute up to $5,500 ($6,500 if you’re age 50 or older) or their taxable compensation for the year, if their compensation was less than this dollar limit. However, a Roth IRA contribution might be limited based on tax filing status and income.
Roth IRAs are great because you can withdraw your money tax-free when you’re in retirement. Or you may want to contribute to a traditional IRA and get an income tax deduction. However, that deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. Review the IRS guidelines for more details.
Also, if you’re a new business owner, you may find yourself in a lower tax bracket than when you were at your corporate job. That means it might be a good time to convert an old 401(k) or traditional IRA into a Roth. That means you can capture lower taxes today and withdraw that money from your Roth tax-free when you’re in retirement.
If you have more money to contribute to retirement than $5,500 ($6,500 if you’re age 50 or older), then you may want to invest in one of the following retirement accounts.
The Solo 401(k)
The Solo 401(k) is a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse. A business owner can make the following contributions:
- Elective deferrals of up to 100% of earned income up to a maximum annual contribution of $18,000 in 2015 and 2016, or $24,000 in 2015 and 2016 if age 50 or over; plus
- Employer non-elective contributions up to 25% of compensation, with total contributions not to exceed $53,000 for 2015 and 2016.
Note that these elective deferral limits apply per person, not per plan. So if you’re also participating in another employer’s 401(k), say if you’re starting your business while still employed at a corporate job and making 401(k) contributions to take advantage of an employer match, these will count against the limit for employee contributions to an individual 401(k) or SIMPLE IRA.
And keep in mind that a solo 401(k) plan is generally required to file an annual report on Form 5500-SF if it has $250,000 or more in assets at the end of the year. A solo 401(k) with fewer assets may be exempt from the annual filing requirement. And your solo 401(k) must be set up by December 31st and funded by your tax return due date in order for contributions to apply for that year.
Simplified Employee Pension Plan (SEP IRA)
A SEP IRA is like a traditional IRA, but it is funded solely by employer contributions. A business owner sets up an IRA for each qualifying employee and can contribute up to 25% of each employee’s pay (and 25% of net self-employment income). Annual contributions are limited to the smaller of $53,000 or 25% of compensation for 2015 and 2016. There are no “catch-up” contributions like the solo 401(k).
The SEP IRA is a great option for those who do not qualify for a solo 401(k), or who have employees and are looking for a retirement plan for their company. Business owners just need to file a form with the IRS (Form 5305-SEP) and open a SEP IRA at a bank or financial institution.
Savings Incentive Match Plan for Employees (SIMPLE) IRA:
A SIMPLE IRA is a retirement plan available to any small business with 100 or fewer employees that doesn’t currently maintain any other retirement plan. It’s a great starter plan that encourages contributions by employees. The plan is funded by employee salary reduction contributions and/or employer contributions.
Employees can decide how much they’d like to contribute, up to $12,500 in 2015 and 2016. Employers have two options:
- Match up to 3% of each eligible employee’s compensation (which can be reduced to as low as 1% in any two out of five years). The amount, however, can’t exceed $12,500 ($15,500 for employees age 50 or older, applies to both the 2015 and 2016 tax years); or
- Contribute 2% of each eligible employee’s compensation. The amount, however, can’t exceed $5,300 in either the 2015 or 2016 tax years.
How to Choose
Which tax-advantaged retirement plan should you use? That depends on the nature and size of your business (are you solo or have employees?). Additionally, you need to consider your tax filing status, age, and participation in other retirement plans. And since some plans require more administrative and fiduciary responsibilities, you may want to chose one retirement plan over another due to simplicity. If you need help deciding which plan is best for you, I’m happy to discuss your retirement planning needs in more detail.
Pay Yourself First!
Finally, in order to reach your financial goals, you need to pay yourself first. This is important even if you aren’t a business owner! You can achieve this by setting up automatic transfers to your savings, retirement, and/or investment accounts. As an entrepreneur, your income may vary, so allocate your savings based on percentages instead of dollar amounts. For example, make it a goal to set aside 5% of every client payment. This will automatically help you save more dollars when your income is higher and keep you from overextending yourself during leaner months.
If you’re looking to organize your finances and plan for a brighter future, here’s how we can work together.
