YourNextSuccess: Building Financial Freedom Like a Boss

by Lauren Zangardi Haynes of Words on Wealth

How the Self-Employed Athlete Can Build Wealth

Being your own boss is great, and now that you have got a handle on your cash flow you may be wondering “what do I need to do to really create financial freedom?” The good news is, as an independent earner you have plenty of choices regarding the type of account you use to save for retirement. The bad news is, you have a lot of choice in the type of account you use to save for retirement.

Unfortunately, choosing a long-term investment strategy structure can be really confusing, but take courage! Today we’re going to break down three simple accounts and help you decide which one works best for you. This post assumes you are a solo-entrepreneur and do not have any employees.

Before we get started, let’s not lose sight of the most important rule of retirement savings: start today. Don’t let indecision cost you valuable time. When it comes to long-term investments, time is literally money (aka, compound interest).

Let’s get started – how much are you planning on saving this year?

Is it $5,500 or less? If so, then an IRA may make the most sense for you. IRAs are quick and easy to set-up and fund. No matter how large they get, you don’t have to file any retirement plan-related forms with the IRS. There are two types of IRA’s we’ll explore here, each of which could make sense depending on your financial situation.

Traditional IRAs for the Self-Employed

“I want to save up to $5,500 and get a tax break today while doing it.”

A traditional IRA allows you to deduct your contribution against your current income (translation: you don’t pay income taxes on the amount you contribute to a traditional IRA). While your money is in the traditional IRA it grows tax-free (no annual taxes on interest or capital gains). However, when you take the money out in “retirement,” or your “work optional” days, you will owe income taxes on the money. There’s something else important to know about traditional IRAs – if you take money out of a traditional IRA before age 59 ½ you will also owe a 10% penalty to the IRS. That hurts…so don’t take money out of your IRA before age 59 ½.

Traditional IRAs work well for people who want or need a tax-deduction now on their contributions. If you are NOT covered by a retirement plan at another job then your contributions are tax deductible, regardless of your income. There is some nuance here around the deductibility of your contributions, you can read more here and be sure to check with your tax or financial advisor.

If you are married and filing jointly there is a little bit of nuance around the deductibility of your contributions. If neither spouse is covered by a retirement plan at another employer then there is no income limit on the deductibility of your contributions. If you are self-employed and your spouse is covered by a plan at work then you can deduct your contributions until your household adjusted gross income reaches $189,000 for 2018. For more details around income limits and the deductibility of your contributions check out this online document from the IRS.

When does a traditional IRA not make sense?

Are you earning more money now than you think you will in retirement? Would a tax deduction make it significantly easier for you to save? If you answered yes then a traditional IRA may make sense for you. However, if you think you will be in a higher tax bracket during retirement than you are now, an account called a Roth IRA may be a better choice.

Roth IRAs for the Self-Employed

“I want to save up to $5,500 and not pay any taxes when I take the money out in retirement.”

Roth IRAs have an important twist on the traditional IRA – you don’t get a tax deduction up front on your contributions today, but your money grows tax-free until retirement and you get to withdraw it tax-free in retirement. Roth IRAs are great accounts for younger workers with lower incomes (and thus a lower tax rate).

I’ll be honest, a lot of financial planners love Roth IRAs – and with good reason. They can provide you with tax diversification in retirement (which means you may be better able to control your taxable income by balancing withdrawals from tax-deferred and tax-free retirement accounts). Roth IRAs also have some increased flexibility around withdrawals before retirement as well.

The Roth IRA is unique in that you can withdraw your contributions penalty and tax-free at any time. But only your contributions. If you withdraw earnings before your account has been open for 5 years and you reach age 59 ½ you may face taxes and penalties on that withdrawal. There are a couple of additional exceptions to this – one big one is for first time home buyers. You can use Roth IRA funds penalty and tax-free for a qualified first-time home purchase if the account has been open for 5 years or more. Don’t do this. Leave your money in the Roth; that future tax-free money could be so valuable in retirement.

Once you reach age 59 ½ and your Roth IRA has been open for at least 5 years you can withdraw your funds without taxes or a penalty under current law. For more details on Roth IRA distributions rules that may allow you to access your money in a Roth IRA before age 59 ½ check out this post from

When does a Roth IRA not make sense?

First, there are income limits on who can contribute to a Roth IRA. Second, if you are struggling to save and getting an income tax deduction on your IRA contribution would help you to save more it may be worth it to forgo the Roth IRA and choose a traditional IRA. Third, if you want to save more than $5,500 then a Solo-401(k) may be a better choice for you.


“I’m setting PRs and I want to save up to $18,500!”

There is a lot to like about solo-401(k)s – which is just a cute name for a 401(k) plan with one participant. For starters, you can save up to $55,000 in a 401(k) per year. Yes, you read that correctly, and better yet, that number has a tendency to increase every couple years. An employee under age-50 can contribute $18,500 in 2018 but the employer (again, you) can contribute an additional $36,500. There are some limits around how much the business can contribute to a solo-401(k). Talk to your tax preparer or finanical advisor. You can also get a quick synopsis here.

With a 401(k) you can allow Roth contributions (after-tax), as well as the traditional tax-deductible contribution, and, potentially, loans. I say “potentially” because even though 401(k)s can easily be set-up with loan provisions, many of the low-cost providers do not offer loan provisions in order to keep their costs low.

Note: I generally do not recommend you take loans from your 401(k).) Unlike IRA’s, solo-401(k)s may have different provisions depending on the provider. When you interview solo 401(k) providers ask some or all of these questions:

  • Do you allow Roth contributions?
  • What investment options do you offer?
  • What set-up costs and annual fees do you charge?
  • What costs are there to invest within the plan?
  • Do you allow loans?
  • How are accounts funded? Do you have to mail a check in every time or can they debit your checking account?
  • Do you allow rollovers from old 401(k)s into the account?

Keep in mind that once your 401(k) reaches $250,000 in assets you will need to file a form 5500 with the IRS. This is a pretty straightforward form, particularly for a single employee plan, but it is something to be aware of.

Also, if you are employed by another company and have another 401(k) plan you are contributing as well, you need to aggregate your contributions across both plans to make sure you aren’t accidentally over-contributing. For example, if you make $100,000 and contribute 3% to your other employer’s 401(k) so you can capture the max, you could only contribute an additional $15,500 in employee contributions to your own solo-401(k).

Bonus Section: HSAs

Do you have a High Deductible Healthcare Plan (HDHP)? If you have a HDHP that qualifies you for a Healthcare Savings Account (HSA); this can actually be a great opportunity to augment your retirement savings. You don’t have to spend money saved in an HSA in the year it is saved. You can invest it and let it grow for the future. Under current tax law HSAs are triple-tax preferred. Yes, that’s a thing.

Let me explain, when you contribute to an HSA you get a tax deduction in the year you make a contribution, your money grows tax-free inside the HSA and when you take the money out for qualified medical expenses it’s tax-free. The key here is that the funds be spent on qualified medical expenses. If you withdraw funds in retirement (after age 65) for non-medical expenses you will have to pay taxes on the money you take out. Still – an HSA can be an awesome supplement to your retirement and a critical tool for individuals with HDHPs.

So, which account type is best?

If you are planning on saving $5,500 or less then an IRA or Roth IRA is the simplest way to go. If you would like to save more money you should definitely explore the solo-401(k). Either way, pay close attention to your investment costs and try to keep your investment options broadly diversified and straightforward.

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