Retirement can be an exciting new chapter, especially for those who start a side hustle , follow passion projects, or begin consulting businesses. However, navigating Social Security benefits as a self-employed individual can be complex.
Understanding how your self-employment income impacts your benefits is crucial to maximize your financial well-being. Here are nine key points to consider.
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1. You must pay Social Security taxes
As a self-employed individual, you're required to pay Social Security taxes on your earnings. These taxes are essential as they fund your future Social Security benefits.
It's important to budget for these taxes to ensure you remain compliant and can benefit from the system when you retire.
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2. Self-employed workers are responsible for both employer and employee portions of Social Security taxes
Unlike traditionally employed individuals, self-employed workers must pay both the employer portion (6.2%) and employee portion (6.2%) of Social Security taxes. This amounts to a total of 12.4% of your net earnings.
While this may seem like a hefty sum, it's crucial for securing your Social Security benefits in the future.
3. Income deductions will lower income and also may lower your Social Security benefits
Deductions such as business expenses can reduce your taxable income when you're self-employed. While this can lower your tax bill, it also reduces your net income, which is used to calculate your Social Security benefits.
It's a delicate balance between minimizing taxes and maximizing future benefits. Carefully consider the long-term impact of deductions on your retirement benefits.
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If you choose to work while receiving Social Security benefits before reaching full retirement age, your benefits might be reduced if your earnings exceed certain limits.
For 2024, the earnings limit is $22,320. If you exceed this limit, your benefits will be reduced by $1 for every $2 you earn above the threshold.
5. You only need a minimum of 10 years of work (or 40 credits) to receive benefits
To qualify for Social Security benefits, you need to accumulate 40 credits, which equates to about 10 years of work. Each year, you can earn up to four credits based on your earnings.
This is an important milestone for self-employed individuals planning their retirement.
6. Your Social Security taxes are calculated based on your net income during self-employment
The amount of Social Security taxes you owe is based on your net income, not your gross revenue. Net income is calculated by subtracting your business expenses from your total earnings.
It's crucial to keep accurate records of all your business expenses to ensure your net income is correctly calculated.
Find Out: 8 must-do things before 60 for a stress-free retirement 7. Your Social Security benefits are calculated based on your 35 highest-earning years
Social Security benefits are determined by averaging your 35 highest-earning years. If you have fewer than 35 years of earnings, the missing years will be factored in as zeroes, which can significantly reduce your benefits.
For this reason, it's beneficial to have consistent earnings throughout your career, including your self-employed years.
8. For 2024, the Social Security tax cap is $168,600
There is a cap on the amount of earnings subject to Social Security taxes. For 2024, this cap is set at $168,600. Earnings above this threshold are not subject to Social Security taxes, which can affect high earners differently than those earning below the cap.
9. Don't include your earnings from other sources when estimating your Social Security benefits
Only earned income from work, including self-employment, is considered when calculating your Social Security benefits. Other sources of income, such as investments or rental properties, do not count toward your Social Security earnings record.
Make sure to distinguish between earned income and passive income when planning your retirement benefits.
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Understanding how self-employment impacts Social Security benefits is essential for retirees and soon-to-be retirees venturing into new business opportunities.
Knowing the rules and managing your earnings effectively can help you stretch your retirement income and enjoy a stress-free retirement.
Whether you retire early to pursue a passion project or need to supplement your Social Security , it's important to understand how these decisions will affect your benefits while working and when you’re retired.
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