I’ve witnessed an interesting trend happening among corporate executive clients. Many have been leaving their jobs at large companies and setting up their own consulting businesses. After the grind of 60-hour-plus weeks, they are finding plenty of advantages: a good income, more control over their schedule, and a choice of clients and projects that interest them.
In a recent survey by reverse mortgage lender American Advisors Group, almost half (46%) of the more than 1,500 Americans aged 60 to 75 surveyed said they plan to work part time after they retire from full-time work.
Based on numerous positive comments I’ve heard from clients who have made this transition, I’m bringing this concept up in many retirement planning discussions with executive clients who are still working full time. I share how one client began receiving consulting opportunities even before they are officially retired. Another told everyone he was going fishing for six months. But when he returned, the work was waiting, and he now has a robust consulting business.
One important aspect about working for yourself is how to re-create the benefits you probably got from your former employer. A self-employed person, like a consultant, has several options that, just like their employer’s plan, will enable them to keep saving for retirement while reducing their taxes.
Here’s a quick summary of the financial items you need to know before making the switch to consulting:
Saving for Retirement When You’re Self-Employed
A self-employed person can establish a solo 401(k) retirement plan, a Simplified Employee Pension (SEP) plan and, if they earn enough income, a cash balance pension plan. In some cases, they will be able to save more money on a before-tax basis than in their former employer’s 401(k) plan.
- With a solo 401(k) plan, The self-employed person can defer $20,500 of their income into the plan if they are under age 50 or defer $27,000 of their income if age 50 or over. Plus, the self-employed person can make an “employer” contribution on their own behalf, for a total maximum deposit of $61,000 in 2022 (or $67,500 for those age 50 and above). A best practice is to establish the solo 401(k) plan by Dec. 31 As you are supposed to make your deferral election by that date, but you have until your tax return filing deadline to put money into the account and claim the deduction on your tax return.
- A SEP IRA allows you contribute up to 25% of your self-employed income, not to exceed $61,000 for 2022. The SEP IRA can be established and funded anytime before you file your tax return and claim the deduction.
- Cash balance plans enable high-income business owners or self-employed persons to accelerate their retirement savings and realize significant annual tax deductions. The amount you can defer into these plans is based on many factors, including your age, income and plan document rules. In some cases you can sock away hundreds of thousands of dollars on a before-tax basis each year, which is tremendous if your income is high enough that you don’t need it all to live on.
Health, Life and Disability Insurance Options
Many people who have worked for large companies for a long time are shocked to learn what small-business owners and self-employed individuals pay for insurance. In some cases, electing COBRA makes sense for a period of time after you leave your large employer if you don’t have a group retiree medical plan to enroll in, or don’t yet qualify for Medicare at age 65. Otherwise:
- You could buy coverage through the Affordable Care act. If you carefully manage your income, you could qualify for subsidies to help cover the costs.
- You could pursue coverage through a spouse or partner’s workplace policy.
- You could shop for a short-term plan to fill the gap until you’re eligible for Medicare.
Aside from health insurance, most employer plans don’t allow you to keep your group term life and disability insurance plan once you leave, or if you can, you must convert them to individual policies and pay the corresponding (and higher) premium.
If you still need this type of insurance coverage, start shopping early. Disability insurance could be very difficult to secure as a new business owner or self-employed individual because you don’t have a regular earnings history in your new gig. For life insurance needs, term life insurance can often be a wise choice since the premiums are lower and may stay fixed for the term of the policy.
Taxes: Be Prepared for a Bigger Bite (and Some Possible Deductions)
A self-employed person will pay a new set of taxes compared to working for a large company. For example, you will pay the employer’s share of Social Security and Medicare taxes. For 2022, the Social Security tax rate is 12.4% on self-employment income up to $147,000. There is no such income cap for Medicare tax; you pay the Medicare tax rate of 2.9% on all self-employment income.
On the other hand, you are entitled to several tax deductions to offset the cost of running your small business. While this is not specific tax advice, some examples include: a home office, computer, printer, cellphone, car lease payments and mileage. You may also deduct travel expenses – airfare and hotel to visit a client – and dinner with clients and colleagues if business is conducted.
Financially, making the transition from a corporate job to self-employment helps a person make a smoother transition from a large paycheck. As the workforce of today’s business world continues to change, it’s good to know you have this option.
Partner and Wealth Advisor, CI Brightworth
Lisa Brown, CFP®, CIMA®, is author of “Girl Talk, Money Talk, The Smart Girl’s Guide to Money After College” and “Girl Talk, Money Talk II, Financially Fit and Fabulous in Your 40s and 50s”. She is the Practice Area Leader for corporate professionals and executives at wealth management firm CI Brightworth in Atlanta. Advising busy corporate executives on their finances for nearly 20 years has been her passion inside the office. Outside the office she’s an avid runner, cyclist and supporter of charitable causes focused on homeless children and their families.