What are retirement options for self-employed?

Self-employment gives individuals a certain measure of freedom, but it also means figuring out how to save for retirement on your own. Unlike employed workers who enjoy the convenience of employer-sponsored retirement plans such as 401(k), self-employed individuals don’t have a workplace retirement plan to opt into.

Self-employed individuals can save for retirement using either a Solo 401(k), SEP IRA, SIMPLE IRA, or a standard IRA. A Solo 401(k) is ideal for a sole proprietor or businesses with no other employees, except the spouse. If the business has a few employees, you can use a SEP IRA to build retirement savings. If you own a larger business with up to 100 employees, you can use a SIMPLE IRA to save for retirement.

What are the Self-employed retirement plans?

A self-employed retirement plan is a retirement savings plan that you can open and contribute to on your own, and you don't need to have an employer to get access to the plan. For some retirement plans, you don't have to be self-employed to open an account. For example, a traditional IRA is available to both self-employed and employed workers.

The main advantage of self-employed retirement plans is the tax incentives they provide. Depending on the retirement plan you have, you may be allowed to make tax-deferred contributions and get an immediate tax break. If you have a Roth IRA or Roth Solo 401(k), you will pay taxes on contributions but you won’t pay taxes on qualified withdrawals from the plan.

When choosing a retirement plan, you should consider several factors, including how much you want to save for retirement, how much you can afford to save each year, and the number of employees you have.

Retirement options for the self-employed

Solo 401(k)

Solo 401(k) plans, also known as one-participant 401(k) plans, are available to owner-only businesses, and they offer the same benefits that are available in a 401(k) plan. These plans are a good choice for individuals looking to enjoy the benefits of a traditional 401(k) but with the potential to make bigger contributions.

A Solo 401(k) allows participants to contribute both as an employee and employer. As an employee, a participant can contribute up to $22,500 in 2023, and an additional $7,500 if they are 50 or older. As an employer, the participant can contribute an additional 25% of their compensation, as long as the total contribution does not exceed $66,000.

A solo 401(k) works like a standard 401(k) plan, and you can choose to contribute to a traditional or Roth Solo 401(k) option.

SIMPLE IRA

If you own a business with few employees, you can use a SIMPLE IRA to offer your employees a retirement plan. This retirement plan is available to self-employed individuals and small business owners with no more than 100 employees earning more than $5,000. Participants can save more than a traditional IRA allows, but less than a Solo 401(k) allows.

Employees who are enrolled in a SIMPLE IRA can set up automatic deductions to contribute to the retirement plan. In 2023, employees can contribute up to $15,500; employees older than age 50 can contribute a catch-up contribution of $3,500.

As the sole proprietor of the business, you can contribute to the retirement plan both as an employee and employer. As an employer, you can contribute up to 3% of net earnings as a dollar-for-dollar match to employee contributions, or 2% of your earnings up to $330,000 in 2023.

SEP IRA

A SEP IRA is a retirement plan available to employers with few employees. This retirement plan only allows the employer to contribute to the plan but not employees. The employer can contribute a maximum of 25% of compensation or $66,000 per year, whichever is higher.

A SEP IRA provides a tax-deferred way to save, but with a higher contribution limit than an IRA. It is non-exclusive to other IRA plans, and you can contribute to the plan and still contribute to other IRAs up to the annual contribution limit.

Traditional or Roth IRA

Anyone with an earned income can open an IRA, including self-employed individuals. Individuals have a choice between a traditional IRA and Roth IRA.

A traditional IRA allows individuals to make pre-tax contributions to the plan and get an immediate tax break, while a Roth IRA allows participants to make post-tax contributions to the account. In 2023, you can contribute up to $6,500 to an IRA, and an additional $1,000 in catch-up contributions if you are above age 50.

A Roth IRA has income limits that determine your eligibility to contribute to the plan. If your annual income exceeds the annual income limit, you won’t be able to contribute to a Roth IRA directly.

If you are a single filer, and your modified adjusted gross income (MAGI) is below $138,000 in 2023, you can contribute to the Roth IRA up to the annual limit. If your MAGI is more than $138,000 but below $153,000, the amount you can contribute is gradually reduced as your income approaches $153,000. If you are married filing jointly and your MAGI is less than $218,000, you can contribute up to the annual limit; if your MAGI is more than $218,000 but less than $228,000, your contributions will be reduced.

How to open a retirement plan if you are self-employed

Once you have decided to open a retirement plan, you must decide where to open the account. Most online brokerages offer various retirement plans, including traditional or Roth IRA, SEP IRA, SIMPLE IRA, and Solo 401(k).

When opening a retirement plan with an online brokerage, the broker will provide the paperwork you need to file with the IRS. You may be required to provide personal information, including your name, Social Security Number (SSN), phone number, legal address, etc.

The set-up process is easy, and it can take about 15 minutes depending on the brokerage. Once you have set up a retirement plan, you can fund it by transferring funds from your savings or checking account, wire transfer, direct deposit, or rollover from another retirement plan.

Other Self-Employed Retirement Plans

Apart from the retirement plans listed above, self-employed individuals and small business owners may have several other ways to save for retirement.

Profit sharing plan

A profit-sharing plan is a retirement plan that gives employees a share of the company’s profits. There is no set amount that participants can contribute in a particular year. If you cannot afford to make payments in a specific year, you do not need to make contributions. Also, the business does not need to earn a profit to contribute to a profit-sharing plan.

Money purchase plan

A money purchase plan is a retirement plan that requires the employer to make pre-tax contributions on the employee's behalf. These plans require the employer to contribute a fixed percentage to the plan, usually up to 25% of compensation.

The retirement plan states the required contribution percentage. For example, if the money purchase plan requires a 5% contribution of each employee’s pay, the employer will be required to contribute 5% of each eligible employee’s pay to their separate account.