As a self-employed freelance writer, I spent hours researching and learning about how to invest money in different self-employed retirement plans. When you’re a self-employed worker or run a small business, these retirement savings plans are not an automatic benefit like an employer-sponsored 401(k) or pension plan that many employees receive as part of their job.
Thankfully, there are a number of self-employed retirement plan options, but each comes with its own benefits and limitations. Here’s everything you need to know about self-employed retirement plans and how to choose the right plan for you.
Traditional or Roth IRA
An individual retirement account — IRA for short — is a type of retirement plan that anyone can use, including self-employed individuals. You can contribute to an IRA in addition to other self-employed retirement plans, and depending on your income and the type of account you choose, you may be able to take advantage of tax savings.
- Traditional: Receive a tax deduction for contributions to your traditional IRA today. Your money grows tax-deferred. When you withdraw from your account, you pay taxes at your marginal tax rate. There are income phase-outs for claiming the tax deduction, however, so higher earners may not be able to get the most tax advantages from traditional IRAs.
- Roth: Roth IRAs also have income thresholds, but if you qualify by making less than a certain amount of money each year, you can make contributions with after-tax dollars. Your money grows tax-free and when you withdraw, you don’t have to pay taxes on the amount.
However, there are some limitations that can reduce the value of an IRA, depending on your situation:
- In 2023, IRA contribution limits are set at a maximum of $6,500 of your taxable compensation for the year, whichever is less. If you’re age 50 or older, that limit goes up to $7,500.
- Contributions made in excess of the annual limit will be taxed at 6% for each year they remain in the IRA.
- Depending on your modified adjusted gross income on your tax return, you may not be able to contribute to a Roth IRA, or you may be subject to a lower total contribution limit.
- Your MAGI may also impact your ability to deduct contributions you make to a traditional IRA. IRA deduction limits can vary based on whether you also have an employer-sponsored retirement plan.
- If you take withdrawals from an IRA before you reach age 59 1/2, you may have to pay taxes on the amount plus a 10% penalty for early withdrawals. There are, however, exceptions to this rule.
Because of the nature of IRAs, they can be a great way to supplement savings you’ve put into a self-employed retirement plan. However, because of their low annual contribution limit, they’re not the best option as a primary retirement plan.
Also called a one-participant 401(k), a solo-k, a uni-k, or a one-participant k, a solo 401(k) is designed specifically for small business owners who have no employees (other than a spouse, if applicable).
Generally, a solo 401(k) functions similarly to an employer-sponsored 401(k). You’ll make contributions with pre-tax dollars, and these contributions will grow tax-deferred until you take withdrawals in retirement.
There are, however, a few differences besides the single-participant nature. For starters, as the business owner, you can make contributions as yourself and also as the employer:
- In 2023, you can make employee contributions of up to $22,500 as an individual; if you’re age 50 or older, you can add another $7,500 in catch-up contributions.
- As the business owner, you can make employer contributions of up to the lesser of 25% of the employee's compensation, or $66,000 in 2023.
Those employer contributions can also be counted as a business expense, further reducing your tax liability each year. Depending on which plan provider you go through, solo 401(k)s are relatively inexpensive. For instance, I paid a few hundred dollars to set up mine, plus an ongoing monthly fee of $25.
Unlike with an IRA, you may be able to set up a loan option with your solo 401(k), though interest charges will be involved. In addition, doing something like taking a 401(k) loan to pay off debt and borrowing from your own retirement should be considered only as a last resort.
All that said, here are some potential drawbacks of a solo 401(k) to consider:
- As with IRAs, if you take withdrawals from a solo 401(k) account before you reach age 59 1/2, you’ll be assessed taxes plus a 10% penalty. Although there may be options to allow loans or hardship withdrawals, there are fewer exceptions to the 10% early withdrawal penalty than you’d get with an IRA.
- You’re not eligible to open this plan if you employ anyone besides yourself and your spouse, though 1099 workers don’t count.
- You may not be eligible if you’re also covered under an employer-sponsored retirement plan — for example, you work as an employee at a company and also run a side business in your spare time.
Because of how a solo 401(k) is set up, you might consider it if you’re an independent contractor or sole proprietor with no salaried employees — though, you can still qualify even if you employ your spouse.
A Simplified Employee Pension IRA is a type of IRA that you can establish to benefit you, your employees, or both. The primary difference between a SEP IRA and a traditional or Roth IRA is that only an employer can contribute to a SEP IRA.
The maximum contribution amount for each eligible employee, including yourself, is the lesser of 25% of the employee's compensation, or $66,000 in 2023. A SEP IRA functions similarly to a traditional IRA for tax purposes, which means your earnings will grow tax-deferred. Also, your contributions as the employer are tax-deductible.
If you want to make separate contributions to a traditional or Roth IRA, you can. In some cases, however, you may be permitted to make your personal IRA contributions to your SEP IRA.
Here are some potential issues you might run into with a SEP IRA:
- A SEP IRA allows only employer contributions, unlike a solo 401(k), which allows you to contribute to your self-employed retirement plan as an individual and an employer.
- If you have employees, you must contribute the same salary percentage for each person participating in the plan. That includes employees who are no longer employed on the last day of the year.
- If you take a withdrawal before age 59 1/2, you’ll need to pay income tax and a 10% penalty on the distribution. There are, however, some exceptions to the 10% penalty requirement, which are the same as traditional and Roth IRA exceptions.
- You can’t borrow from a SEP IRA as you can a solo 401(k).
A SEP IRA is for business owners who want the simplicity and lost cost of an IRA, but with a much higher contribution maximum. There’s also less paperwork involved than with a solo 401(k).
A Savings Incentive Match Plan for Employees IRA allows both employers and employees to contribute to a traditional IRA. In 2023, you can contribute $15,500 as an individual or an extra $3,500 if you’re age 50 or older. The same limit applies to any employees. As the employer, you can also choose to make a nonelective fixed contribution of 2% of compensation or a matching contribution of up to 3%.
Because the SIMPLE IRA is designed as a traditional IRA, your contributions are tax-deductible in the year you make them, and your earnings will grow tax-deferred. You can also contribute to a traditional or Roth IRA on your own.
Here are some important things to know about the SIMPLE IRA:
- Although the structure of a SIMPLE IRA is similar to a solo 401(k) in that you can contribute as the employer and individual, its contribution limits are lower.
- You can’t borrow from a SIMPLE IRA as you can from a solo 401(k).
- You may need to work with a special custodian to open a SIMPLE IRA account.
- Withdrawals made before age 59 1/2 will be subject to income tax and a 10% penalty, though there are the same exceptions to the penalty as other IRA plans.
Consider a SIMPLE IRA if you want the chance to contribute as the business owner and an individual, but don’t expect to need the higher plan contribution limits of a solo 401(k). This self-employed retirement plan is also better if you have employees and don’t qualify for a solo 401(k).
A Health Savings Account isn’t technically a retirement plan, but you can use one to set money aside to use in retirement. You can use this account in addition to one of the other self-employed retirement plans and a traditional or Roth IRA. In fact, I contribute to both a solo 401(k) and an HSA every year.
HSAs are available to taxpayers, including business owners, who have a high-deductible health plan. You can set aside money in the account to use for out-of-pocket medical expenses on a tax-free basis. In other words, your HSA contributions are tax-deductible, and you won’t pay any taxes when you make withdrawals for eligible medical expenses. If you take withdrawals for ineligible reasons, the amount will be subject to income taxes plus a 20% penalty.
That said, if you hold onto your HSA funds until you’re 65 or older, withdrawals for non-medical reasons will still be subject to income tax but not the additional 20% penalty. As a result, an HSA can function similarly to a tax-deferred retirement account. Of course, you can also use HSA funds to pay for health care costs in retirement and avoid all tax-related costs.
In 2023, you can contribute up to $3,850 to an HSA if you’re the only one on your health insurance plan or up to $7,750 if you have a family plan. Depending on your HSA provider, you may be able to invest these funds.
If you’re considering an HSA, here are some things to keep in mind:
- Because it’s not a traditional retirement plan, it’s not a good idea to rely solely on an HSA to save for your future.
- You won’t qualify for an HSA if you don’t have a high-deductible health plan.
- HSA contribution limits are lower than most other self-employed retirement plans.
If you qualify, consider an HSA as a way to supplement your other retirement contributions. Keep in mind, though, that any ongoing medical expenses may make it challenging to use the funds to save for retirement.
Other retirement plans
Depending on your personal financial situation, you may also consider other types of small business retirement plans. Here are a few less-common options that self-employed people might consider:
- Keogh plan: A tax-deferred pension account, a Keogh plan allows you to set up a defined-benefit or defined contribution plan. Keogh plans are relatively complicated and require more upkeep and costs than other types of self-employed retirement plans.
- Defined-benefit plan: With a Keogh plan or a separate defined-benefit plan, you’ll make contributions based on a set amount you aim to receive annually in retirement. There may be contribution limits, though, depending on how you plan to structure the plan.
- Profit-sharing plan: With this type of retirement plan, employees get a share in the profits of the business. There are no contributions from the employee with this type of plan, and contributions by the business will depend on quarterly or annual earnings.
Take some time to consider all of your options to determine which retirement plan is right for you. Also, consider consulting with a tax professional and/or financial advisor to get an idea of which financial plans would benefit you most when it comes to your tax planning.
How to open these plans if you’re self-employed
In most cases, you can get any of these self-employed retirement plans from a major brokerage firm. In some cases, some brokers may not offer certain types of plans, so decide which plan you want to go with before you start shopping around.
As you compare brokers and their self-employed retirement plans, review several features, including:
- Cost (setup and ongoing fees)
- Ease of use and access
- Administrative help
- Investment options (mutual funds, ETFs, etc.)
- Resources and advice
There’s no single best investment broker for everyone, so it’s important to take your time and consider how to choose a brokerage that’s best for you and your business.
What is the best retirement plan for a self-employed person?
The best retirement plan for a self-employed person is the one that meets your needs. Consider your tax strategy, income needs, and contribution limits.
Look for a plan that will allow you to set aside enough money each year to potentially grow your nest egg while helping you maximize your tax efficiency. Don’t forget to consider the requirements for contributions if you have employees.
Can you have a 401(k) if you are self-employed?
If you’re self-employed, you can open a solo 401(k) and make contributions. However, you can’t use a solo 401(k) if you have other employees other than your spouse. Instead, you’d have to set up an IRS-approved program to provide retirement benefits to the rest of your employees.
What is the difference between a SEP and a SIMPLE retirement plan?
The main difference between a SEP and a SIMPLE retirement plan lies in who contributes to the plan. With a SEP, the employer makes contributions to their own plan, as well as to the plans of the employees.
There is no way for employees to make their own contributions to a SEP IRA. A SIMPLE IRA, on the other hand, allows for a situation in which employees can make their own contributions, with the employer matching contributions.
Self-employment comes with a lot of perks. But without an employer-sponsored retirement plan, you’re responsible for making sure you have everything in place to save for your future. Saving for retirement sooner rather than later is important because it gives you more options when you’re ready to slow down or stop working entirely.
Think about your financial goals, ability to save, and tax situation to help you determine which retirement plan is the best option for you. Also, consider the costs, upkeep, and potential pitfalls associated with each plan. The retirement planning process can take some time, but getting the right account set up could make it easier to avoid costly retirement mistakes in the long run.
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