Retirement Planning
October 12, 2023

Saving for Retirement When You’re Self-Employed

Saving for retirement when you’re an employee can be fairly simple: Contribute 10–15% to the company’s retirement plan. When you are the employer, it gets more complicated.
Stewart Willis

Saving for Retirement When You’re Self-EmployedSaving for Retirement When You’re Self-EmployedSaving for retirement is never simple, but it’s a little less complicated when you work for someone else. Put 10-15% of your salary into your 401(k). If you can’t, contribute at least enough to take advantage of any matching contributions from your employer.


However, when you’re self-employed, it gets a little more complex. There’s no HR professional telling you to sign up for benefits and no company 401(k) plan from which to choose investments. If you want to save for retirement, you have to do it without in-house help.


That extra layer of complexity, though, is accompanied by more opportunity. If you retire from an employer, you get your retirement savings or, if you’re particularly fortunate, start collecting a pension. When you retire from the company you own, you not only get your retirement savings, but you also get to take advantage of the value you’ve built up in your company over the years. If your business has done well, this can represent a sizable cash infusion to supercharge your retirement just as it begins.


Start Early

Most people work for a decade or two before they start thinking seriously about retirement. If they’re wise, they save for retirement from the beginning, but they often don’t have much of a retirement strategy; when you’re in your 20sand 30s, you have other things to worry about such as buying a home, finding a spouse and raising a family.


When you work for yourself, you don’t have that luxury. You need to be putting yourself on track for retirement from the first day you open for business. There are a number of avenues to consider as you begin preparing for an event that is decades away.


Tax Efficiency

Whether you own your own business or work for someone else’s, many people fail to take taxation into account when planning for retirement. That can be a huge mistake! If you aren’t constantly considering the tax impact of your retirement planning decisions, you risk stepping on a tax land mine at one of the worst possible times — just as you enter retirement and give up your paycheck.


Owning your own business gives you an advantage others lack: You get to choose your retirement savings vehicle. Most employees contribute to a 401(k) because that’s what their employer offers. As regular readers of my blog know, a 401(k) is a tax-deferred retirement account. Contributions to a 401(k) come out of your paycheck before that paycheck is taxed. This is nice because it lets you save the entirety of your contributions rather than your contributions minus income tax.


But few things in life are entirely advantageous, and the tax-deferred nature of401(k)s are no exception. The tradeoff for not paying taxes on the money you contribute is that you will pay taxes when you withdraw that money in retirement. The trouble is that, while we know today’s tax rates, we don’t know what they will be in the future; most experts expect them to be higher.


What that means is,  any money you withdraw will be taxed at the, likely higher, ordinary income tax rate. Beyond that, any gains that money makes while in the 401(k) will also be taxed at the ordinary income rate, rather than the, likely lower, capital gains tax rate. In short, a significant chunk of your 401(k) retirement savings could be spent paying taxes rather than funding your retirement.


As a self-employed business owner, you aren’t limited; since there’s no company match to obtain, you can choose not to save in a tax-deferred account. Rather, you can open a Roth 401(k) or, if you’re a sole proprietor, a solo Roth 401(k).You’ll pay taxes on contributions when you make them, but gains and withdrawals in retirement are tax free.


Your Portfolio Includes Your Business

Perhaps the most difficult part of saving for retirement when you’re self-employed, because it involves making yourself replaceable, is considering your business to be part of your retirement portfolio. Your business needs to be a viable enterprise without you at the helm. It must be able to continue operating profitably with you completely out of the picture. Why? Because if it’s not, no one will want to buy it from you when you’re ready to retire!


This is hard: Not only is it an ego drain to intentionally set it up so you have to admit your business can do just fine without you, but commonly, that business is your “baby.” You can’t imagine ever wanting to give it up! To many business owners, preparing their company for their own exit is the scariest thing they’ll ever do, but it’s a vital step toward positioning your company as a valuable commodity you can sell to help fund your retirement.


This is not just something I tell business owners to do; it’s something I do myself as a business owner. Every day, I step back and try to make sure the operations of Asset Preservation Wealth & Tax can continue without me. Personally, I do this mainly out of a sense of responsibility for our clients. Bluntly, if I get hit by a bus tomorrow, I don’t want my clients’ finances to be jeopardized as a result. That the firm’s continued viability without me in charge will considerably enhance my own retirement financials is in many ways secondary to that consideration, but certainly plays a part in my decision-making.


I learned the importance of this the hard way. My mother ran a very successful day spa in California when I was younger. Her business soared in the 90s, but when the dotcom bubble burst, her therapists started leaving, looking for greener pastures far away from anything resembling Silicon Valley.


By the end, she was running the business by herself. She was still making a great income but had nothing left to pass on to a new owner; it was a good way for her to earn a living, but she had no business to sell to help fund her retirement.


Above all, don’t simply grow your business and mechanically put money away without considering what you will actually need in retirement. Especially as you approach retirement, consider your cash flow needs. I’ve said it before, but it bears repeating: It’s a big mistake to set a target number that you “need” for retirement without arriving at that number through cash flow analysis.


Despite the many articles available which confidently tell you you’ll need $1 million, or some other impressive number, what you’ll actually need depends on your goals and unique circumstances. Some can retire with far less than $1 million in savings. Others retiring on $1 million would run out of money in just a few years.


Consult with your financial advisor to determine your desired retirement lifestyle and the cash flow level that will likely be needed to support it. This will give you a much more informed perspective on what you need in order to retire, and it will help avoid the worst-case scenario of retirement failure. After all, it’s much easier to not retire if you aren’t ready than it is to retire and have to reenter the workforce because you’ve run out of money.


Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.


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