When you make investments that are not part of a retirement program, you’ll pay taxes on earnings, such as interest from a savings account or profit from a stock sale. With qualified retirement accounts, you don’t pay a penny in taxes on the earnings until you retire and begin withdrawing money. Not only are taxes delayed for many years, but by then you should be in a lower tax bracket, so you’ll pay less in taxes.
In addition, most retirement plans allow you to deduct contributions from your reported income. That means if you make $40,000 and contribute $2,000 to a qualified plan, you report only $38,000 on your income tax return.
The most-utilized qualified plans for owner-operators are Individual Retirement Accounts. Contributions can be put into certificates of deposit, money-market accounts, savings accounts, mutual funds, stocks and bonds. A banker, stockbroker or mutual fund company can help you set it up.
TRADITIONAL IRA. You are allowed to contribute $7,000 a year, tax-deferred, to an IRA, through tax year 2024 with a catch-up contribution limit of $1,000 for individuals age 50 and older. As long as you’re not covered by an employer-sponsored retirement plan, IRA contributions reduce your taxable income and are tax-deferred. If you or your spouse contributes to an employer-sponsored plan such as a 401(k), only a portion of your IRA contribution is deductible. Your IRA funds cannot be withdrawn before age 59.5 — except under special circumstances — without incurring a hefty penalty.
ROTH IRA. The differences between a traditional IRA and a Roth IRA are the terms of contributions and payout. With a Roth IRA, contributions are not deducted from income, so they are taxable for the year they’re earned. But they do accumulate tax-deferred and are tax-free when withdrawn.
SIMPLE IRA. The SIMPLE (Savings Incentive Match Plan for Employees) IRA was designed for companies with fewer than 100 employees. If you employ others, you and your employees qualify.
Under a SIMPLE IRA arrangement, an employee of your business can contribute to and be matched by you up to $16,000 in 2024, with a $3,500 catch-up contribution limit for those 50 and older.
SEP IRA. A Simplified Employee Pension plan offers possibly larger contributions for high earners in that it allows an employer/sole proprietor to contribute up to 25% of net income (up to $69,000 total for the 2024 tax year) to an IRA set up for himself or his or her employees. After money is put into the plan, it must stay there until the owner turns 59.5. Early withdrawals are subject to federal income taxes and a possible 10% penalty.
If you pay yourself as an employee of the business in an S Corp arrangement, the SEP contribution is limited to 25% of your W2 income.
[Related: How to set up an owner-operator business as an S Corp to save on self-employment tax]
You can set up an SEP for a year as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan. This is where filing for an extension may benefit your planning, enabling careful considerations without rushing the process if you’re just starting the journey toward saving for retirement.
INDIVIDUAL 401(k). For years, 401(k) retirement plans, another form of tax-deferred savings, were limited to employees, often with an employer match as a savings incentive. Since 2001, however, individuals have been free to set up solo 401(k)s, which have an annual contribution limit of up to 25% of income or $23,000, whichever is lower, as long as you are classified as an employee of your own business (such as in an S Corp structure) and are paying yourself a salary. If you’re self-employed, the rules are more complicated. See IRS publication 560’s rate table and worksheets for determining your contribution limits.
ROTH 401(k). A somewhat newer retirement plan option is a combination of the Roth IRA and the solo 401(k) called the Roth 401(k): Money you put into it is taxed in the year you earned it, but never again. Many financial advisers believe a Roth 401(k), along with the Roth IRA, is among the best deals for an owner-operator.
Assuming that taxes will go up in the long term is the safest of bets, so paying now locks in the lower rate. The more taxes you can pay while you’re younger, the better.
An example of investments in practice was on offer in 2024 as the August Trucker of the Month in Overdrive‘s Trucker of the Year competition, owner-operator Alan Kitzhaber, detailed his 35-year run of retirement investments. He utilized a multi-account strategy, with both a more-traditional pre-tax investment vehicle and a post-tax Roth IRA, seeing the latter as a way to tap investments in retirement without impacting his tax liability substantially in retirement.
Most important to his 35 years of investing, successfully setting himself up for retirement in 2025: Consistency, in a word. “I’ve been very religious about investing my money instead of spending it,” and keeping it invested, he said. “It’s put me in a position where I can feel comfortable retiring.”
Hear more about his strategy in this September 2024 edition of the Overdrive Radio podcast: