A self-employed person rubs his forehead in frustration as he contemplates his financial plan

Wealth and Financial Planning for the Self-Employed

The perk of being self-employed is having the freedom to make your own choices — which also comes with more responsibility. Here’s what you need to know about financial planning, funding your retirement, insurance coverage, and estate planning when you’re self-employed.

Published by Motley Fool Wealth Management Tue, May 28, 2024

read time 4 min read

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According to the Bureau of Labor Statistics, over 16.7 million people were classified as self-employed as of March, 2024.1 That number covers everyone from people who own their own companies, to owners/partners in professional firms such as law, accounting, and medicine, to sole practitioners in a variety of service and consulting functions, and part-timers who may have a side gig in addition to their regular full-time job.

Self-employment has a lot to recommend it, but it can also make wealth and financial planning more complex. Let’s go over some of the high-level considerations you may want to explore.

Financial planning

Just like someone who works for an employer, someone who is self-employed needs to have an overall financial plan to both manage money in the short term and cover retirement and estate planning for the long term.

Unlike someone who works for an employer, however, someone who is self-employed may not have the steadiness of a regular income. They may need larger emergency funds, structured ways to save for taxes, and a strategy for how to meet their long-term financial goals that accounts for the income variability.

Retirement planning

If you’re self-employed, saving and investing for your retirement is entirely on you. While you won’t have access to a traditional 401(k), there are options specifically for people who are self-employed, including small business owners.

A Solo 401(k) is an individual 401(k) plan that allows employee contributions up to the annual 401(k) limits. Additionally, employer profit sharing contributions can be made for up to 25% of your compensation from the business. Solo 401(k)s are limited to the business owner and a spouse involved in the business. Non-owner employees are not eligible to participate in the plan.2

A SEP-IRA is a retirement plan designed for small businesses with employees. All contributions are made by the employer; there are no employee contributions allowed. In fact, the business owner must contribute the same percentage of compensation for any employees as they do for themselves.3

A SIMPLE IRA is a small business retirement vehicle designed for businesses with 100 or fewer employees, although it also can be used by self-employed people with no employees. The employer is required to make either a matching contribution or a set rate contribution on behalf of the employees.4

A small business 401(k) can be a good option for someone who is self-employed and whose company has employees. A 401(k) offers access to high employer contribution limits. The downside is that smaller 401(k) plans can be expensive.

A personal defined benefit pension plan can be somewhat expensive, but it can be very beneficial for those who want to be able to generate a dependable, steady stream of income in retirement.

If you have 401(k)s or similar retirement plans from a prior employer, be sure that money is in the most effective vehicle available for your needs. This might entail rolling the money over to an IRA, or leaving the money in the original plan.

Exit planning

For many people who are self-employed, their business represents a significant asset. When it’s time to leave the business — whether that’s retirement or shifting to another business — it’s important to have a plan for realizing the value of that asset.

  • Sell the business to an outside buyer, or perhaps to key employees in the business. This can involve a one-time cash payment, or payments over time.
  • A buy/sell arrangement with partners in the business is often funded by a life or disability policy, and is triggered by the owner’s death or disability.
  • Sell to a competitor. In the case of a professional practice such as a medical practice, a law firm, or an accounting firm, this can serve the dual purpose of realizing the asset’s value, and ensuring that patients or clients are well-served after you leave.
  • Liquidate the business by selling assets in the business. This could include inventories, property such as buildings and land, as well as other assets such as copyrights, proprietary technology, and others.

Insurance coverage

Earning money is one thing. Not losing it is another. Insurance can help ensure that a crisis, whether it be a health crisis or a business crisis, doesn’t decimate you and your loved ones financially.

  • Life insurance provides a death benefit for the self-employed person’s heirs that can offset any lost income in the event of an early death. Term insurance can often be a good option, especially for those who are younger but still need a high death benefit.
  • Disability insurance can be more important than life insurance. The odds of experiencing a disability that prohibits you from working, at least for a while, is generally higher for a younger person compared to the odds of them passing away.
  • Liability insurance can take several forms. In the case of a medical or professional practice, professional liability insurance will cover some or all of a judgment against you arising from malpractice in the course of your business. Business liability insurance will cover liability in the event of multiple varieties of accidents and other types of injuries or damages caused by some aspect of your business. A personal umbrella policy can also provide coverage to you as an individual for a variety of liability issues.

Estate planning

Although estate planning is often associated with older folks, it's important for people of all ages. Having an estate plan can make the transition easier for your loved ones.

In addition to an up-to-date will and accurate beneficiary designations, estate planning for someone who is self-employed will often include the following.

  • If you have any sort of buy/sell arrangement for your business, be sure that your family is aware of the terms and any insurance policies linked to the transaction.
  • If there is someone who could be a likely buyer for your business in the event of your death, be sure your family is aware of this, including any arrangements that might have been discussed.

Conclusion

Creating a comprehensive financial and retirement plan when you’re self-employed may be more complex than it would be for someone who works as an employee, but it’s important to set yourself up for long-term success.

A financial advisor who is comfortable working with people who are self-employed, and a strong tax professional, can both provide solid advice for your financial and wealth planning efforts.




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Sources:

1 U.S. Bureau of Labor Statistics, Accessed 4/18/2024.

2 IRS: One Participant 401(k) Plans, Accessed 4/23/2024.

3 IRS: Simplified Employee Pension Plan (SEP), Accessed 4/23/2024.

4 IRS: SIMPLE IRA Plan, Accessed 4/23/2024.

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