When you’re self-employed, you don’t have as many built-in protections as many employees have. You’ll be responsible for your own health insurance, disability insurance and retirement planning. Many employees not only have the opportunity to contribute to a 401(k) plan but they also benefit from company matches. If you’re self-employed, you’ll have to play the role of both employee and employer. Fortunately, there are plenty of great retirement plans available to self-employed individuals. Here are the primary options.
Solo 401(k) Plan
Many business owners are unaware that they can create their own 401(k) plans, known as solo 401(k) plans. But the truth is that a properly run solo 401(k) plan can be even more advantageous than a company-sponsored 401(k). This is because as a business owner, you can make contributions to a solo 401(k) both as either an employer or an employee (or both), making your potential maximum contribution level much higher.
For 2021, employees can only contribute up to $19,500 to their 401(k) plans, with an additional $6,500 “catch-up” contribution permissible for those ages 50 and older. While these same limits apply to a solo 401(k), you could also choose to make a profit-sharing contribution of up to 25% of your compensation as an employer, with a limit of $58,000 for 2021. This limit also benefits from the 50-and-older “catch-up contribution,” pushing the maximum to a whopping $64,500.
A SEP-IRA was one of the first retirement plans devised for the self-employed. With a SEP, you’re allowed to contribute up to 25% of an employee’s compensation into a SEP retirement account. The caveat with a SEP is that you must contribute the same percentage to each employee’s account as you put in your own. This makes the SEP ideal for a sole proprietor or single-owner business, as the only account you’ll have to contribute to is your own.
The maximum you can contribute to a SEP-IRA is the lower of $58,000 or 25% of your compensation. Note that catch-up contributions are not allowed in a SEP-IRA, making the total contribution limit slightly less than with a solo 401(k) plan.
As the name suggests, a SIMPLE IRA, short for Savings Incentive Match Plan for Employees, is a way for employers to set up individual retirement accounts for themselves and their employees without the complexity of other plans, like a solo 401(k). Employers are required to make annual contributions to SIMPLE IRAs, so again they can be ideal for one-person businesses.
Annual salary reduction contribution limits for employees in 2021 are $13,500, with an additional $3,000 in catch-up contributions allowed for those 50 and older. Employers are required to make either nonelective contributions of 2% of each eligible employee’s contributions or a matching contribution of up to 3%.
Defined Benefit Plan
Defined benefit plans aren’t as common these days, but they are still available to the self-employed. These traditional pension plans offer a specific annual retirement benefit that’s typically based on salary and years of service. For 2021, the maximum annual benefit can be up to $230,000. You aren’t required to make contributions to a defined benefit plan, but the paperwork and filing requirements can be complex.
Traditional or Roth IRA
Both traditional and Roth IRAs are individual retirement accounts available to all qualifying taxpayers, not just the self-employed. However, as a self-employed individual, they still remain an option for retirement savings. Traditional and Roth IRAs don’t have the same complicated reporting requirements as the more formal business retirement plans listed above, making them a more convenient option for some. However, contribution limits are greatly reduced compared to some other plans, like the solo 401(k) or the SEP-IRA. Traditional and Roth IRA contributions are limited to $6,000 for 2021, with an additional $1,000 catch-up provision for those ages 50 and older.
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