One essential precondition to building wealth is financial stability, with positive cash flow and no harmful debt. This typically means a budget and savings plan.
A monthly written budget gives every dollar an assignment, and it helps you see how your expenses compare to your income. This gives you a big-picture view of where to make changes.
If you’re self-employed, consider a solo 401(k) or Simplified Employee Pension (SEP) IRA as a way of saving for retirement. Both options allow you to set aside up to 25% of your net adjusted self-employment income. However, contributions to a SEP IRA are restricted to a maximum of $57,000 per year. In addition, these plans do not offer a Roth option.
With a solo 401(k), you can contribute as an employee and an employer. As an employee, you can defer up to $22,500 in 2023 (with a $7,500 catch-up contribution for those over 50). These are the same limits that traditional employees are authorized to contribute to their own 401(k) plans.
You can also make profit-sharing contributions on behalf of your business. The limit is generally 25% of your compensation or net adjusted self-employment income, which is your net profit from self-employment, less half of your self-employment tax and plan contributions to your solo 401(k).
If you have multiple 401(k) accounts associated with different employers, you can combine the annual employee and employer contribution limits for each plan. However, this is unnecessary since the limit for individual contributors is per calendar year, not each account. The only exception to this rule is if you have a Roth solo 401(k) designated funds converted from an after-tax IRA.
Employer matching of employee 401(k) contributions is one of the great benefits of workplace retirement plans. It’s free money added to your retirement savings, and it’s something that you should take advantage of if it’s offered.
Your employer will contribute the same as your contribution dollar-for-dollar up to a specific percentage of your salary, typically 3 percent. You can find your employer’s 401(k) match amount in your plan documents or ask your company’s human resources representative.
It’s important to understand that your 401(k) contributions are made with pretax dollars. This means that you will only pay taxes on these funds once you retire, and then you will be in a lower tax bracket. As such, it’s a good idea to save as much as you can in your 401(k) during your working years.
Self-employed individuals not in a traditional corporate plan for retirement, such as a Simplified Employee Pension (SEP) IRA or a SIMPLE IRA, can significantly contribute to their retirement with an Individual 401(k). In 2023, you can give up to $22,500 as the employee and an additional 25% of earned income as the employer. The combined total of these two amounts can be at most $66,000 or $73,500 if you are 50 or older. These high limits make an Individual 401(k) the most popular individual 401k options for freelancers and other independent contractors.