4 Retirement Plans for the Self-Employed

Senior businesswoman is doing paperwork in her stock factory
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Being self-employed has major appeal, such as the financial freedom to expand your business on your own terms; opportunity for partnerships or acquisition; and the freedom to wear pajama bottoms all day. However, it’s not all wine and roses — or coffee and flannel — for that matter. You’re the boss now and no one is going to take care of you but yourself. There are some major mistakes that could be made, and failing to adequately plan for retirement is one of them.

Only 13% of self-employed Americans who run a single-person business have a workplace retirement plan, with around $50,000 saved in it on average. Those are some frightening numbers, but not nearly as terrifying as entering retirement without any savings to support you.

If you are self-employed, squeezing extra money out of your budget can be tough. Your income might be unpredictable and cash flow might be tight. It can be hard to prioritize retirement when you are trying to build a business, and the various retirement plans offered can be overwhelming.

The most common retirement accounts for the self-employed are SEP IRAs, SIMPLE IRAs and individual 401(k)s. Keogh plans are also available, but they are less common. All of these plans have up-front tax breaks and tax-deferred savings. Here is a summary of the four plans to help you decide which is best for you.

Solo 401(k)

A solo 401(k), also known as a solo-k or uni-k, is a one-participant 401(k) plan; you are the administrator and the contributor. Contributions are made on a pre-tax basis and you can contribute up to $22,500 in 2023 with an additional $7,500 in catch-up contributions if you are over 50 years old. This plan is best for self-employed people with high incomes and no other employees (except a spouse), or older self-employed people who are behind in their retirement saving and need to catch up.

Are You Retirement Ready?

What makes these plans particularly appealing is that in addition to the $22,500 maximum contribution, you can also contribute up to 25% of your net self-employment income. If your spouse is an employee (they must work for the business and be paid a reasonable salary), he can also contribute the same amount, essentially doubling your investment. Finally, for self-employed people who receive an inheritance or windfall, a solo 401(k) can act as a tax shelter.

There are some drawbacks, though. If you hire employees other than a spouse, you are no longer eligible for a solo 401(k) and will have to convert it to a regular 401(k). Finally, if your solo 401(k) has over $250,000 in it, you will have to go though the hassle of filling out additional paperwork with the IRS.

Solo 401(k) plans are offered by most major financial firms and are fairly easy to set up. You can withdraw from a solo 401(k) under certain circumstances but not all firms offer this option, so make sure to ask. There is also a Roth version of this plan but you won’t get an up-front tax break, although the money will continue to grow (and eventually be withdrawn) tax-free.

Tip: Some financial experts recommend using a separate federal Employer Identification Number (EIN) for your solo 401(k) to simplify your taxes. You can get one from the IRS website.

Simplified Employee Pension IRA (SEP IRA)

This is perhaps the most simple self-employed retirement plan available: it’s a great choice for business owners without employees or moonlighters (regular workers with self-employed income on the side). You can have a SEP IRA if you have employees, but there are strict conditions for an employee to be eligible. The 2023 maximum contribution for a SEP IRA is up to 25% of your net self-employment income or $66,000, whichever is less.

Are You Retirement Ready?

The SEP IRA’s flexibility is what makes it particularly attractive: you can wait to fund the plan until you file your taxes, in case your income is higher than expected, and then make a larger contribution to avoid a higher tax bill. If you make less than you expected, you can scale back your contribution.

You can also open a SEP IRA any time before your business’ tax-filing deadline – it does not have to be opened before the first of the year. You can also take longer to contribute to your SEP IRA by filing for an extension. Some business owners do this regularly to give themselves more time to contribute money to the plan and maximize the tax benefits.

There are a few disadvantages: The contribution limits of a SEP IRA are lower than a solo 401(k). Remember a solo 401(k) allows you to contribute up to the 20% net profit plus an additional $22,500. Also, with a SEP IRA there are no catch-up contributions allowed. So if you are nearing retirement and just starting to save, this might not be the best option for you. Finally, loans from SEP IRAs are not allowed but you can withdraw the money at any time. You will pay penalties, so it’s not a decision to take lightly.

Tip: Treat your SEP IRA contribution like a regular bill and schedule automatic payments directly into the plan.

Savings Incentive Match Plan for Employees (SIMPLE IRA Plan)

A SIMPLE IRA is a type of traditional IRA for small business owners with 100 or fewer employees, and the self-employed, with aspirations of growing their businesses. The contribution limits max out at $15,500 for 2023 (plus an additional $3,500 if you’re 50 or older). You also cannot maintain any other retirement plans, including SEP IRAs or qualified plans. Unlike the SEP IRA, there is no income restriction — you can put a full 3% of your net self-employment income into the plan.

Are You Retirement Ready?

What really makes the SIMPLE IRA stand out is that the employer is required to make a contribution on the employee’s behalf in one of the following ways: either dollar for dollar, up to 3%of the employee’s salary or a flat 2% of pay, regardless of whether the employee contributes to the account. You, the employer, will benefit from major tax deductions, both from your own contributions and employee deferrals. You will also have the added benefit of attracting and retaining quality employees.

This might sound a little complicated, but SIMPLE IRA plans really are, well, simple. They are generally easier and cheaper to start up and maintain when compared to qualified plans. Employees can contribute through regular paycheck deductions and are not required to provide annual financial reports.

You can open a SIMPLE IRA between Jan. 1 and Oct. 1 of each year. If you become self-employed after Oct. 1, you can set up a SIMPLE IRA plan for the year as soon as administratively feasible after your business starts. Loans from SIMPLE IRAs are not allowed but you can withdraw the money at any time with penalties. The penalties are severe, however: 25%  if made within the first two years of participating in the plan.

Tip: Make sure your employees are eligible before starting a SIMPLE IRA plan.

Keogh Plan

Keogh plans were once popular for the self-employed but have now been largely replaced by SEP IRA plans. Until 2001, Keogh plans allowed for larger annual investments than other retirement plans, which is what made them appealing to many business owners. Now, the contribution limits for both Keogh plans and SEP IRAs are the same.

Are You Retirement Ready?

The Keogh is also more difficult to set up, making it a less-desirable plan for the self-employed, and you cannot participate if you qualify as an independent contractor. Keogh plans are still an option for self-employed individuals who own their own unincorporated businesses (sole proprietorships, partnerships and LLCs), but the SEP IRA is usually recommended over this plan.

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Sam DiSalvo contributed to the reporting for this article.


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