Introduction

I am starting a series on financial planning for young people who are starting their professional lives. I want to focus on professionals where they are the business. These would be the sole proprietors and business owners whose bottom line on their QuickBooks statements shows a profit from one month to the next.

Now that you are making some money, the question should focus on when one is no longer working. As I tell my students, there is a person you will meet one day, and you will owe them money. Guess who it is? It will be you when you turn 65 or older. You must pay your future self some money now in the form of a retirement account. The question is, which one is best for you?

Roth IRA

A Roth IRA is an individual retirement account where one can invest their money tax-free. Currently, the contribution limits are $7,000 per year, and that will be money that has already been taxed. Once you turn 59 ½, any distributions you take will be 100% tax-free. So, the immediate advantage to a Roth is that a portion of one’s retirement income is tax-free. There are additional advantages to a Roth:

• There are no required minimum distributions (RMDs): Unlike the rest of the retirement plans that will be mentioned, you are not required to make any distributions.
• If you must take any early withdrawals, you can withdraw your contributions (not your earnings) without penalties or taxes. It should be noted that this should be for emergencies only.
• You can pass your Roth to heirs and their distributions are generally tax-free

A Roth IRA is recommended if one can save less than $7,000 per year and when finding tax deductions is not a major concern.

Traditional IRA

A traditional IRA is an individual retirement account where one can invest money tax-deferred. The contribution limit is $7,000 per year, like the Roth IRA. The difference is that one receives an immediate tax deduction for their IRA contributions, and when they retire, the future distributions are taxed. If one expects to be in a lower tax bracket during retirement, then the traditional IRA is a good option. It also might be the only option if one earns too much money to be eligible for a Roth. Also, one may need to reduce their taxable income now, so a traditional IRA has an immediate benefit. Here are some additional benefits from a traditional IRA.

• Tax-Deferred Growth. All gains made in an IRA before retirement are tax-deferred. No money is taxed until a distribution is taken.
• Immediate Tax Deduction. If one’s effective tax rate is 20%, a traditional IRA can save them up to $1,400 on their taxes.
• No Income Limits. There is no income limit for contributing to an IRA. They are accessible to everyone.
• Some Penalty-Free Withdrawals. I want to highlight that an early distribution before one is 59 ½ years old is a taxable event and can come with a 10% penalty. There are some exceptions to certain qualified expenses such as a first home purchase, birth, or college expenses.

Simplified Employment Pension (SEP) IRA

A SEP IRA is a retirement plan designed for self-employed individuals and small business owners. I will say now that this is an option for those people who need to make a tax-deferred contribution of over $7,000 per year. Currently, the contributions one makes to a SEP IRA is limited to $69,000 per year or 25% of one's compensation, whichever is lower. If I were to use the 10% rule to save, one should consider a SEP IRA if their income is more than $70,000 per year. This would be important for those who want to comfortably save for retirement. It should be pointed out, that if one does start a SEP IRA, their employees must be included in the program, so that is a consideration.

Generally, I only recommend SEP IRAs for people who work as sole proprietors with no employees, or who are independent contractors for other businesses, and no other retirement plan options are available.

So, Which Is Better?

The question for which is better comes down to whether to pay taxes now or later. As a rule of thumb, I loosely use the following guidelines:

• If one knows they will earn less than $39,500 in 2025, then the Roth IRA is the best option. The standard deduction for a single filer in 2025 will be $15,000. If one is earning only $39,500, their taxes will be around $2,700. $39,500 is also the threshold limit where one might be eligible for certain tax credits (up to $200) on retirement savings.
• Using the 10% retirement savings rule, if one knows they will earn less than $70,000 per year, a traditional IRA is a sound option. As an illustration, if one knows they will earn $70,000 per year, and they contribute $7,000 into an IRA, they could save themselves up to $1,492 in taxes.
• Again, using the 10% retirement savings rule, if one knows they will earn more than $70,000 per year, and there are no employees to consider, then the SEP IRA should be considered. If one knows they will earn $100,000 in 2025, a $10,000 contribution will save them up to $2,200 in taxes.

One should also be aware of the upcoming 2025 tax brackets. This should help one in their decision-making for which IRA is best for them.

The 2025 federal income tax brackets are as follows:

• 10%: Up to $11,000 for single filers; up to $22,000 for married couples filing jointly.
• 12%: $11,001 to $44,725 for single filers; $22,001 to $89,450 for married couples filing jointly.
• 22%: $44,726 to $95,375 for single filers; $89,451 to $190,750 for married couples filing jointly.
• 24%: $95,376 to $182,100 for single filers; $190,751 to $364,200 for married couples filing jointly.
• 32%: $182,101 to $231,250 for single filers; $364,201 to $462,500 for married couples filing jointly.
• 35%: $231,251 to $578,125 for single filers; $462,501 to $1,000,000 for married couples filing jointly.
• 37%: Over $578,125 for single filers; over $1,000,000 for married couples filing jointly.

I hope this is useful information, and if you need, please feel free to reach out to me.

Information

Thomas Pound is a financial advisor at Cedar Green Financial in Cape Coral Florida. He is licensed to do business in Florida, Vermont, the District of Columbia, Ohio, and Rhode Island.

You can contact Thomas at 802-779-5509 or [email protected]. You can also find more information at www.cedargreenfinancial.com