10 Retirement Planning Tips for the Self-Employed

Understand How Social Security Works
Don't let this happen to you! If you reduce your net earnings too much to avoid paying taxes, you could end up receiving little or nothing in Social Security benefits. iStockphoto/Thinkstock

Self-employed workers in the United States are entitled to Social Security benefits just like regular employees. That's because self-employed people pay an additional self-employment tax (SE tax) every year that covers contributions to both Social Security and Medicare. The downside of self-employment is that you pay the entire 15.3 percent Social Security tax yourself [source: Social Security Administration]. Conventional employees only pay half and the boss covers the rest (that's called the payroll tax).

How much money will you receive in Social Security benefits? That depends on how much money you earned and how many years you worked. The Social Security Administration requires a minimum amount of 40 "credits" (generally, 10 years). In 2013, you receive one credit for every $1,160 in net self-employment earnings, although the minimum earnings requirement is $4,640 (or four credits). Use this calculator to estimate your future Social Security benefit using your current earnings information. If you were born after 1959, you would have to wait until 67 to get your full benefit amount [source: SSA].

Notice that credits are based on net self-employment earnings. There is a potential trap here. Since self-employed folks pay 15.3 percent in Social Security tax, a lot of people try to lower their taxable income as much as possible by deducting a lot of business expenses. Be careful! If you reduce your net earnings too far, you may not earn the 40 credits to qualify for Social Security benefits [source: Humphreys].

Finance Planning Tips

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