Mary Beth Franklin: Self-employment a halfway house for retirement
January 8, 2013 by Mary Beth Franklin
I spent part of my Christmas holidays estimating my tax liability for 2012. Exciting stuff, huh? But rather than the usual gnashing of teeth that accompanied many of my tax-filing season computations in the past, I was pleased with my initial tally of income and expenses in my first year as an independent contractor.
After writing for a consumer audience for decades, I was thrilled to have the opportunity to reach a new audience of financial advisers through my column for Investment News. But I wanted to tackle this new challenge on my own terms, as a consultant, not as an employee. It’s been an exciting endeavor that fits well with my pursuit of another goal: a Certified Financial Planning credential. (Six courses completed; one to go!)
As I tackled this transitional career, I followed the advice that I doled out to my readers over the years: the tax planning values of self-employment. I’m lucky. My husband is a full-time federal employee, so he covers our health insurance needs. And his long-term civil service will provide us both with retiree health benefits for life.
Being self-employed, I must pay both the employer and employee portions of the Social Security and Medicare payroll taxes (although I enjoyed the 2% tax holiday on the employee portion in 2012). But I also get to take advantage of this dual role in saving for retirement.
I opened a solo-401(k) before the end of the year, allowing me to contribute up to $22,500 as a 50-plus employee. Plus, before I file my 2012 tax returns, I’ll also be able to contribute up to 20% of my net self-employment income, which is my net income minus half of my FICA taxes.
The maximum contribution for a solo 401(k) for 2012 is $55,500. That beats the maximum amount allowed under a SEP IRA, which does not include a catch-up provision for those 50 and older. And, because of the dual contribution formula, I can contribute more to a solo 401(k) than I could to a SEP IRA at the same income level.
The long-term care insurance premiums that I pay for me and my husband are also deductible—up to the IRS maximum for our ages. That’s something I was never able to deduct on my federal return because—luckily—our medical expenses never exceeded 7.5% of our adjusted gross income. If I paid our medical insurance premiums, that would also be deductible as a business expense, too.
All the equipment and furniture that I purchased last year to outfit my home office qualify for a first-year write off (although I could choose to depreciate them). And my day-to-day office supplies and unreimbursed travel expenses are deductible, too.
Unlike presidential candidates, I’m not in the habit of disclosing my tax returns (or tying family pets to the roof of my care, for that matter). But I think it can serve as a helpful reminder to advisers working with clients who are transitioning into retirement. Part-time consulting or other home-based businesses can hold some attractive income-generating and tax-planning opportunities on the way to full-time retirement.
