3 Best Retirement Strategies If You Are Self-Employed
Being self-employed has major appeal, such as the financial freedom to expand your business on your own terms, the 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.
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You’re the boss now and no one is going to match contributions but yourself. Some major mistakes could be made, and failing to adequately plan for retirement is one of them.
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Quick Take: Retirement Plans
When it comes to saving for retirement there are many ways to enhance your earning potential such as taking full advantage of employer contributions or looking into profit-sharing plans. However, if you are self-employed you may need to familiarize yourself with what kind of retirement plans are out there. Here are some examples:
Traditional Individual retirement accounts or IRAs
SIMPLE IRA Plan
Simplified Employee Pension IRA (SEP IRA)
Defined Contribution Plan
Federal Thrift Savings Plan
401(k) Plan
Solo 401(k) Plan
403(b) Tax-Sheltered Annuity Plan
Cash Value Life Insurance Plan
Defined Benefit Plan
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3 Best Self-Employed Retirement Plans
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, especially when trying to factor in if you can even reach the annual contribution limit. 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 important part is to start now in whatever you can to start building your retirement funds. Here are some of the best options for retirement plans if you are self-employed:
Solo 401(k)
Simplified Employee Pension IRA
SIMPLE IRA (SEP IRA)
1. 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 increased to $23,0000 in 2024 and are some more key takeaways:
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 savings and need to catch up.
What makes these plans particularly appealing is that in addition to the $23,000 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.
For self-employed people who receive an inheritance or windfall, a solo 401(k) can act as a tax shelter.
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.
Solo 401(k) plans are offered by most major financial firms and are fairly easy to set up.
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.
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 through the hassle of filling out additional paperwork with the IRS.
2. 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 such as the following considerations:
The 2023 maximum contribution for a SEP IRA is up to 25% of your net self-employment income or $66,000, whichever is less. This increased to $69,000 in 2024.
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.
Treat your SEP IRA contribution like a regular bill and schedule automatic payments directly into the plan.
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 or 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.
The contribution limits of a SEP IRA are lower than a solo 401(k).
3. SIMPLE IRA Plan
A SIMPLE IRA is a type of traditional IRA and savings incentive match plan for employees for small business owners with 100 or fewer employees, and the self-employed, with aspirations of growing their businesses. Here are some things you should factor in if you are considering this plan:
The contribution limits max out at $15,500 for 2023 (plus an additional $3,500 if you’re 50 or older). This increased to 16,000 in 2024.
You also cannot maintain any other retirement plans, including SEP IRAs or qualified plans. Unlike the SEP IRA, there is no income restriction.
What makes the SIMPLE IRA stand out is that you as the employer are required to contribute 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. This means you will benefit from major tax deductions, both from your own contributions and employee deferrals.
These plans are generally easier and cheaper to start up and maintain when compared to qualified plans.
Final Take To Go
The bottom line is that 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, according to CNBC. Those are some frightening numbers, but not nearly as terrifying as entering retirement without any savings to support you.
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 advantages and tax-deferred savings so make sure to find the best financial fit for you.
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Caitlyn Moorhead contributed to this article.
This article originally appeared on GOBankingRates.com: 3 Best Retirement Strategies If You Are Self-Employed
