Self Employed? You Can Make $1 Million In 10 Years (Or $3.8 Million in 20)
Are you self-employed and taking a salary in excess of $146,000? What if I told you it was possible to have $1,000,000 in just 10 years, only putting aside $60,500 per year, while also lowering your current taxes? It gets even better. If you use this strategy for 20 years, you’ll come out with $3.8 million, and if you give yourself 30 years the number becomes $10.9 (assumes 10% return).
While most people have heard of standard SEP and 401(k) plans, it turns out that certain tools exist that could more aggressively fund a retirement while still retaining the tax shelter benefits of these more traditional plans. The best part of this strategy, is you only have to put aside $60,500 per year, compounded annually, for this to work. That means if you take a salary of $146,000 (2018), you are left with $85,500 before taxes to live and spend however. – That’s not too shabby.
1 – 2 Person Business (no other employees)
SELF-EMPLOYED 401(K) STRATEGY
If you’re business is solely run by you, or you and your spouse, you have the ability to establish a Self-Employed 401(k). This is different than your run-of-the-mill Corporate 401(k). The Corporate 401(k) maximum contribution limits (for 2018) are capped at $18,500 (the maximum is $24,500 for those over 50). However, the Self-Employed 401(k) allows you to contribute up to a massive $55,000 per year ($61,500 for those over 50 – in 2018).
Much like when you contribute to the Corporate 401(k), the Self-Employed 401(k) is also tax deferred. So if you take a salary of $200,000 – instead of paying taxes on the entire $200,000 you made, you pay tax only on $145,000 ($200K – $55K). If you are in the top tax bracket this can be tax savings of $20,350 per year. Depending on additional household income and how you’re filing, this may lower your tax bracket.
The other important tactic to this strategy is opening and contributing to an IRA or Roth IRA. The IRA allows you to contribute up to $5,500 ($6,500 for those over 50) per year (2018). This $5,500 added with the $55,000 you put in your Self-Employed 401(k) equates to $60,500 in annual savings.
When considering the average annual return for the total stock market, we see that stocks have historically returned around 10% annually. Assuming that you max out your Self-Employed 401(k) and IRA contributions each year ($60,500 per year) – in 10 years with a 10% rate of return – your account will be worth $1,060,636. If you do this for 20 years, at a 10% rate of return, the plan produces $3,811,651 – 30 years and the account balance becomes a magnified $10,947,077.
3 + Person Business (with employees)
SEP IRA STRATEGY
The SEP IRA, like the Solo 401(k), has a maximum contribution limit of $55,000 – but there is a catch. Unlike the Self-Employed 401(k), the SEP IRA mandates that the employer make equal contributions as a percent of salary (as much as 15-25%) for all employees that are:
- over 21 years old,
- work full time,
- and have worked for the company over 3 years.
This works extremely well for a family business, a newer business (under 3 years old if you wish to exclude non-shareholder employees) or an employer willing to add a little bit more for their employee’s retirement.
SIMPLE IRA STRATEGY
If you aren’t able or willing to contribute an equal percent of salary for all of your eligible employees’ retirement accounts, there is another option that still offers tax advantages and retirement savings. – The SIMPLE IRA.
The employer match limits on the SIMPLE are either 2% or 3% – much lower than the SEP’s 15-25%. The SIMPLE IRA requires the employer to make one of two kinds of contributions:
- Dollar-for-dollar matching contributions (not to exceed 3% of the employee’s compensation) on behalf of eligible employees who make elective-deferral contributions.
- A 2% non-elective contribution to all eligible employees, regardless of whether they make deferral contributions.
Unlike the SEP IRA which gives the employee money from the employer (even without the employee contributing), the SIMPLE IRA only requires the employer to offer the benefit. When the employer offers the 3% benefit, the employee must also be willing to put in their own money as well, at a minimum the 3% from their own paycheck (just like a typical 401(k) match). If the employer opts to offer the 2% non-elective contribution, then the employee doesn’t have to put any money in, but it does limit the amount the employer has to contribute to eligible employees.
Now, the caveat here is the maximum contribution limits for a SIMPLE IRA are much lower than the SEP IRA and Self-Employed 401(k). – The maximum contribution limits in 2018 for the SIMPLE IRA are $12,500 (15,500 for those over 50). Remember the 2018 Self-Employed 401(k) and SEP IRA maximum contribution limits are both $55,000 per year.
Back to the Strategy
This works if you own a 1-2 person business with no employees (other than your spouse) and you take a salary of $193,045 or more. You must be willing to max out the contributions to the Self-Employed 401(k) and your IRA, which is a total of $60,500 per year. When contributing the $60,500, compounded annually, after 10 years with a 10% rate of return, you will have $1,060,636, after 20 years you will have $3,811,651, and after 30 years this becomes $10,947,077.
Now with the SEP strategy, if you take a salary in excess of $220,000 this will work. Again, you would put aside $55,000 in your SEP and need to contribute the maximum amount to your IRA or Roth IRA ($5,500 for those under 50 – $6,500 for those over 50) and this equates to $60,500 in annual savings. – Over a 10 year period, compounded annually with the same 10% rate of return, your savings become the same $1,060,636, – in 20 years $3,811,651, – and after 30 years, you will have $10,947,077.
The SIMPLE IRA strategy won’t earn you the same $1 million in 10 years, but you still can have $3.5 million after 30 years. In order to work the SIMPLE strategy, you must be willing to contribute the maximum amount to both your SIMPLE IRA and Traditional or Roth IRA. This means you will be contributing $18,000 per year. ($12,500 for the SIMPLE + $5,500 for the IRA). So, by contributing $18,000 in savings per year, compounded annually, with an assumed 10% rate of return, you will have $315,561 after 10 years – $1,134,045 after 20 years – and $3,256,982 after 30 years. Not bad at all for the small business owner with employees.
Again, there are additional benefits to contributing to a Self-Employed 401(k), SEP IRA or SIMPLE IRA – the tax deferred growth. When you contribute to the Self-Employed 401(k) and SEP IRA, you lower your taxable income by $55,000. Depending on your tax bracket (if you’re in the 37% tax bracket), this can be up to $20,350 in current tax savings each year.
Just think, you could be saving in taxes each year while simultaneously contributing to your retirement. – Making $1 million, $3 million, or even $10 million does not have to be that hard.
Plug in the numbers to see for yourself – Bankrate Investment Calculator https://www.bankrate.com/calculators/retirement/investment-goal-calculator.aspx
Consult a Tax/Financial Advisor for help determining the right business taxation and retirement account.