Retirement Withdrawals for the Self-Employed

Unlike employed individuals, who often have access to an employer-matched retirement plan, as a self-employed worker, you must stash away 100 percent of your cash for retirement with no matched funds. While you could just put your money in savings and investment accounts, there are special retirements accounts that you can qualify for because you work for yourself. These accounts offer benefits, but they also place restrictions on your retirement withdrawals.

  1. Account Types

    • Everyone, regardless of employment status, may open and contribute to a traditional IRA, whose contributions are federally tax-deductible. A traditional IRA limits the maximum annual contribution to $5,000 if you are under age 50 and $6,000 if you are over 50. If your modified adjusted gross income is less than the income limits determined by the IRS, you may open and contribute to a Roth IRA. Roth accounts have the same contribution limits as traditional IRAs, but you pay federal income taxes on your contributions.

      A SEP IRA, on the other hand, is a simplified employee pension account into which only an employer may contribute funds. Because you are your own employer, the IRS qualifies you to make your own contributions to the plan. Unlike a traditional or Roth IRA, you may contribute up to 25 percent of your net self-employment income, with a maximum of $49,000 per year. Your contributions to a SEP IRA are tax-deductible.

    Taxes on Withdrawals

    • Once you begin taking qualified retirement withdrawals from your account, the amount of taxes you pay on your income depends on the type of account you have. Both traditional and SEP IRAs follow the same rules. Because you pay no federal income taxes on the contributions you make to the accounts, you owe the IRS on your total withdrawal during retirement. Withdrawals from your Roth IRA, however, are nontaxable. Because you pay tax on your contributions, your principle contribution earns tax-free interest until you retire.

    Early Withdrawals

    • Because of the tax benefits associated with individual retirement plans, the IRS penalizes you if you take an early distribution. According to the IRS, an early withdrawal occurs when you withdraw money from your traditional, Roth or SEP IRA prior to age 59½. Unless you do so because of a qualified event, such as a first-time home purchase or to pay for a child’s college tuition, you owe federal income taxes on the withdrawal in addition to a 10 percent penalty. If you take an early retirement distribution from your Roth account, you may withdraw the amount of your principle investment tax- and penalty-free, but the IRS subjects your earned interest to tax and penalties.

    Mandatory Withdrawals

    • Though you qualify for penalty-free retirement withdrawals in all three account types at age 59½, SEP and traditional IRA rules require that you begin taking mandatory distributions once you reach age 70½ if you have not already been doing so. You must take your first distribution by April 1 of the year after you turn age 70½, and you must take an additional distribution by Dec. 31 of the same year. Regular annual distributions must ensue after that point in time. If you have a Roth IRA, the IRS will never force you to take a distribution. Your money can grow tax-free for the rest of your life without ever making a withdrawal if you so choose.

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