Everyone - including both employees and small business owners - need to think about their retirement goals. While retirement might seem like a far-away goal, the sooner you start strategizing for it, the easier and more luxurious your retirement will be. IRAs, also known as Individual Retirement Accounts, are an incredibly useful way to grow your retirement funds with tax benefits like tax deductions, tax deferrals, or even tax-free withdrawals in retirement.

Small business owners wear many hats. But planning for your financial future is crucial, and once you put the right processes in place, you can let your money grow with minimal effort. In this article, we'll explore the best IRAs for freelancers and small businesses, help you choose the account that best fits your needs, and empower you to build the retirement you dream of.

Fast Facts About IRAs

• An IRA (Individual Retirement Account) is a tax-advantaged savings account for retirement.

• There are two main types of IRAs: Traditional and Roth.

• SEP IRAs and SIMPLE IRAs are specialized IRAs for self-employed individuals and small businesses.

• Choosing the best IRA depends on your income tax bracket, retirement savings goals, and tax planning goals.

What is an IRA?

An IRA, also known as an Individual Retirement Account, is an investment account that allows you to save money for retirement with tax benefits. Contributions can be tax-deductible, and earnings grow tax-free or tax-deferred depending on the IRA type. Some IRAs even allow you to withdraw the money tax-free in retirement, which is a huge benefit because ordinary income tax rates can take away nearly 40% of your income. This means you keep more of your hard-earned money to grow your nest egg.

You can open as many types of IRAs as you want, but total annual contributions are limited to a dollar amount per year. For 2024, this amount is $7,000 and $8,000 for people over the age of 50 (because the IRS allows a $1,000 catch-up contribution). Let's dive into the specifics and explore the most beneficial types of IRAs for creative business owners below.

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The sooner you start investing in your retirement, the better - all because of compound interest. If you invest $1,000 and it grows at a 10% interest rate for 40 years, it'll grow to $45,259.26, all without you having to do anything. If you invest $1k initially, then continue adding $200 a month, it'll grow to a substantial $1,514,814.69.

The takeaway is that you should start investing in your retirement as soon as possible. Similarly, if you have kids, consider opening a retirement account in their name and adding $1,000 to it. If it grows for 55 years, they'll receive a free $189,059.14 when they retire, without having to do anything. Saving early will give you the time and mental freedom to focus on your art rather than your assets.

Note that these examples assume a 10% interest rate, which is not guaranteed. Real-world results may vary and the results mentioned here may not occur in all situations.

Types of Retirement Accounts

There are several IRAs to consider, each with its own contribution limits, tax advantages, and eligibility requirements. Below, we'll break down the most common types of IRAs for freelancers and small businesses.

Traditional IRA

A traditional IRA is an IRA that allows you to deduct your contributions from your current taxable income, which will generally lower your current tax bill. In contrast, taxes are paid on withdrawals in retirement, whether you withdraw your initial investment or the income earned on your investments (like interest and dividends). In general, traditional IRAs are a great option if you expect to be in a lower tax bracket in retirement than you are today - for example, if you plan on retiring and reducing your income before you start taking withdrawals.

Keep in mind that you must pay taxes at your ordinary income tax rate (the same rate you pay on your regular income) when you withdraw any funds from your traditional IRA. In addition, the IRS (Internal Revenue Service) charges a 10% penalty for withdrawing money from your IRA before you turn age 59 ½. If that sounds like a strange number, we agree. But that's what the IRS considers old enough to withdraw money from a traditional IRA. After you turn age 59 ½, there is no longer a fee. Opening a traditional IRA online can be surprisingly easy.

Roth IRA

In contrast to a traditional IRA, contributions to a Roth IRA are made with after-tax dollars (your regular income that you've already paid taxes on), so contributions are not tax-deductible. This rule is to avoid double-dipping on tax benefits: you either get the tax deduction now and pay taxes later, or you pay taxes now and withdraw the income tax-free later. Qualified withdrawals in retirement (after age 59 ½) are tax free, which makes roth IRAs a great option if you expect to have a good amount of ordinary income in retirement.

Similarly to traditional IRAs, withdrawing income from your Roth IRA before retirement will result in a 10% tax penalty from the IRS. However, unlike traditional IRAs, withdrawing the contributions you've made to your Roth IRA prior to age 59 ½ does not result in a 10% tax penalty. You can withdraw your contributions at any time without being penalized, which can make Roth IRAs more flexible than traditional IRAs. Opening a Roth IRA online is a simple and straightforward process.

SEP IRA (Simplified Employee Pension IRA)

A SEP IRA, also known as a Simplified Employee Pension IRA, is an ideal IRA plan for self-employed individuals and small businesses with few employees. Business owners can contribute to their own SEP IRA plan as well as plans for eligible employees. Contributions to a SEP IRA are tax-deductible for the employer and are excluded from employee income (up to certain limits). Similarly to traditional IRAs, taxes on SEP IRA withdrawals are paid on withdrawals in retirement.

SIMPLE IRA (Savings Incentive Match Plan for Employees)

SIMPLE IRAs (Savings Incentive Match Plans for Employees) are a type of IRA that is available to small businesses with up to 100 employees. Employers must match employee contributions up to a certain percentage (usually 3%), and employers can fund their own SIMPLE IRA plan as well. Similar to a traditional IRA, contributions to a SIMPLE IRA are tax-deductible for employers and employees, and taxes are paid on withdrawals in retirement. The same 10% penalties apply to withdrawals made before age 59 ½, just like with traditional IRAs.

How to Open an IRA

If you're wondering how to start an IRA, we've got you covered. Opening an IRA is a relatively simple process, and it can be done fairly quickly online. Here's what you need to do:

1. Choose an IRA Provider: Many banks, investment firms, and online brokers offer IRAs. Consider factors like fees, investment options, and customer service when choosing a provider. Examples of IRA providers include SoFi, Charles Schwab, Bank of America, Wells Fargo, and more.

2. Select Your IRA Type: Decide between a Traditional IRA, Roth IRA, SEP IRA, or SIMPLE IRA based on your tax situation and retirement goals.

3. Open Your Account: Fill out an application with your chosen provider. You'll need to decide how you want to fund your IRA. The most common method is connecting the IRA to your preexisting checking or savings account and transferring the funds via electronic transfer, but paper checks can also be an option.

4. Start Contributing: Once your IRA is set up, you can start contributing! Note that there are annual contribution limits for IRAs, which can change from year to year. The current contribution limit is $7,000 per year for 2024. You can always check the IRS website for current contribution limits.

IRA Tax Rules

Understanding the tax implications of Traditional and Roth IRAs is crucial. Here's a simplified breakdown:

Traditional IRAs:

Contributions are tax-deductible and earnings grow tax-deferred. However, you pay taxes on withdrawals in retirement, including both your contributions and any earnings. There are annual contribution limits to traditional IRAs - the limit for 2024 is $7,000, or $8,000 for those age 50 or older.

Roth IRAs:

Contributions are made with after-tax dollars (and therefore are not tax-deductible). However, qualified withdrawals in retirement (after age 59 ½) are tax-free, including both your contributions and any earnings. There are annual contribution limits to traditional IRAs - the limit for 2024 is $7,000, or $8,000 for those age 50 or older. Additionally, there are income limitations for contributing to Roth IRAs.

How to Save For Retirement While Staying Creative

Saving for retirement might be easier than you think, and you can set up your retirement account with a relatively small time investment. Similarly, with a small monthly contribution, you can earn outsized returns over the years, and retire with significant savings. Follow the steps below to open your IRA:

• Determine which IRA is right for you: Traditional, Roth, SEP, or SIMPLE. Read over the descriptions of each type that we discussed above.

• The big difference between each IRA type is when you pay taxes: With a Roth IRA, you do pay taxes on income now and do not pay taxes later (in retirement). With traditional, SEP, and SIMPLE IRAs, you do not pay taxes now, and you do pay taxes later (in retirement).

Planning for retirement as a freelancer or small business owner requires taking charge of your financial future as soon as possible. Now that you understand the various types of IRAs available to you as a creative small business owner, their tax implications, and contribution limits, you can choose an IRA provider and start saving for a secure retirement today.

Frequently Asked Questions (FAQs)

How much can I contribute to an IRA in 2024?

The IRA contribution limit for 2024 is $7,000, or $8,000 for those age 50 or older. Make sure you don't go above this limit, as this can result in fines and penalties. If you do go above the limit, you can withdraw the excess to avoid penalties.

What is the difference between a Roth IRA and a Traditional IRA?

The main difference is when you pay taxes. Traditional IRA contributions are tax-deductible, but you pay taxes on withdrawals in retirement. Roth IRA contributions are made with after-tax dollars (so they are not tax-deductible), but qualified withdrawals in retirement are tax-free.

Can I open an IRA if I am self-employed?

Yes! You can open any type of IRA: traditional, Roth, SEP, or SIMPLE. There are even IRAs specifically designed for self-employed individuals, such as SEP IRAs and SIMPLE IRAs, which we dove into above. These IRAs can offer tax advantages for both you and any eligible employees you may have.

What happens to my IRA if I switch jobs?

Your IRA belongs to you, regardless of your employment status. You can leave your IRA with your current provider or roll it over to a new IRA at a different provider.

Can I contribute to both a Traditional IRA and a Roth IRA

Yes, you can contribute to both a Traditional IRA and a Roth IRA, but there are overall contribution limits across both accounts. The contribution limit is $7,000 for 2024 ($8,000 for those 50 or older). Your income may also affect your eligibility to contribute to a Roth IRA.

When can I withdraw money from my IRA?

While you can withdraw money at any time, there is a 10% penalty for withdrawing money from a traditional IRA before reaching the age of 59 ½, with some exceptions for certain qualified expenses. Roth IRA contributions can be withdrawn anytime, tax and penalty-free, but you'll have to pay taxes and a penalty if you withdraw the income earned in your Roth IRA. Traditional IRA withdrawals after age 59 ½ are taxed as income, while Roth IRA withdrawals are tax-free.

Disclaimer: the information provided in this article is for educational purposes only and does not constitute tax, accounting, investing, legal, or financial advice. The information in this article does not take into account your unique financial or business situation or goals, and YCCPA cannot be responsible for reader's financial decision-making. YCCPA's goal is to educate and support you on your creative business journey.

Written by David Kindness, CPA

David is a CPA (Certified Public Accountant) and professional photographer, videographer, and designer based in San Diego, California. Learn more.

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