The 5 Best Retirement Plans for The Self Employed

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Being self employed comes with a great amount of freedom to work when, where, and how you want. It also requires being more responsible for yourself. An important aspect that is often overlooked or postponed is planning and financing your retirement. Retirement is such an important life event that soon all new employees working for employers may be automatically enrolled in employer-sponsored 401k plans (employees will be able to opt-out).

But there is no automatic enrollment for the self employed. You must take responsibility and action to set up your own retirement plan for the self employed. The good news is that you have many of the same options to save for retirement on a tax-deferred basis as employees participating in company plans. Your first step is learning which of the retirement plans for the self employed is best for you…

#1 Solo 401k: The 401k for the Self Employed

Flying solo does give you a lot of options. At the top of the list of retirement plans for the self employed is the Solo 401k which comes with more benefits and fewer restrictions than what major employers offer in a 401k. The Solo 401k is tailored to the business owner or self employed person with no employees (except a spouse, if applicable). Leading the list of benefits is the maximum tax-deferred contribution allowed. Along with being the maximum allowed, the annual contribution limit increases based on inflation.

For 2022, the maximum is $61,000, plus a $6,500 catch-up contribution or 100% of earned income, whichever is less. Adding to the list of benefits making this the best among the retirement plans for the self employed is that you get to decide how much your annual contribution will be. As your own employer, you can contribute up to 25% of your compensation as the employer match. That is five times more generous than the average 401K match for company employees at around 5% of salary up to only $3,000. The limit on compensation that can be used to factor your contribution is $305,000 in 2022.

If you make the maximum contribution of $61,000 plus a $6,500 catch-up contribution (for age 50 and over) your total possible contribution limit is $67,500. If a spouse is also making maximum contributions, the combined annual contribution can be as high as $135,000. And there are many more benefits that come with the Solo 401k…

The Solo 401k comes with checkbook control that enables 100% self-directed investing. Unlike corporate 401ks that only give you only a few investment options, your Solo 401k allows you to invest in almost anything you choose. Many independent-minded investors choose real estate, cryptocurrencies, gold, or investing in private businesses but the choice is yours.

Being able to borrow from your Solo 401k is a benefit not available with other retirement plans for the self employed. You can immediately borrow up to either $50,000 or 50% of your account value. When you repay the loan, it goes back into your retirement account including paying yourself the interest on the loan.

Even if you work for an employer and work for yourself on the side, you can still open and contribute to a Solo 401k. This allows you to collect the other employer’s matching contribution and still max out your tax-deferred savings with a Solo 401k. You don’t want to leave any free money on the table.

Your Solo 401k also comes with subaccounts to give you the most flexibility in how you save for retirement. An important subaccount is the Roth Solo 401k. With a Roth Solo 401k, the earnings are 100% tax-free when you retire but you do pay taxes on the original contributions. Roth accounts are particularly favored by younger people that can grow those tax-free earnings for many years and by people that expect to retire wealthy and could be in a higher tax bracket when deferred taxes come due. Because the Roth Solo 401k is free with the Solo 401k, you can contribute to either one at any time, depending on which is best suited to your current tax situation.

How do I qualify for a Solo 401k?

There are only two elements needed to qualify for a Solo 401k: 1) The presence of self-employment business activity and 2) the absence of full-time employees. Please see our page on Solo 401k qualification for more information.

#2 Self Directed IRA (Traditional or Roth)

A self directed individual retirement account (SDIRA) is another of the retirement plans for the self employed that can hold a variety of alternative investments normally prohibited from regular IRAs. A SDIRA is directly managed by the account holder, which is why it’s called self-directed.

Like a Solo 401k, a SDIRA can be either a tax-deferred IRA or a Roth IRA with tax-free earnings. Probably the biggest drawback to the SDIRA is the small contribution limit compared to the Solo 401k. The maximum amount you can contribute to a SDIRA for 2022 is $6,000 if you’re younger than age 50. People 50 and older can add an extra $1,000 per year as a “catch-up” contribution, bringing the maximum SDIRA contribution to $7,000.

There are other limiting factors compared to a Solo 401k such as the SDIRA does not allow you to borrow from your retirement funds. The Solo 401k also has more investment-funding flexibility like borrowing non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UDFI or UBIT tax). In most cases, the Solo 401k also provides greater creditor protection than a SDIRA.

Still, among the retirement plans for the self employed, a SDIRA does give you control of your retirement account to make individual investment decisions. The experts at Nabers Group will help you get your retirement funds into your control, where they belong.

#3 SEP IRA for The Self Employed

A Simplified Employee Pension IRA (SEP IRA) meets the definition of retirement plans for the self employed but is probably more suitable for small-business owners who have employees. If you establish a SEP IRA and contribute for yourself, you must also contribute for your employees. Essentially, a SEP IRA is like a “group” traditional IRA.

Contributions are tax-deductible and investments grow tax-deferred until retirement when distributions are taxed as income. The best part of a SEP IRA is that it too allows the same generous annual contributions as a Solo 401k, up to $ $61,000 in 2022 (no catch-up contribution for people 50 or older).

But with a SEP IRA, that generous contribution limit also applies to employees. Eligible employees are anyone that is 21 or older, has worked for you for at least three of the past five years, and had a minimum of $600 income from you in 2016 through 2020 or $650 in 2021. In 2022, you must contribute for him or her. If you contributed 20% of your compensation for yourself, you must also contribute 20% of what your employees earn.

However, you don’t have to set it up and administer it as an employer 401k account. Employees own and control their accounts.

Also, there is not a Roth version which means you lose the Roth Solo 401k flexibility of tax-free withdrawals when you retire. But you do retain the Solo 401k flexibility of not having to contribute every year – no contribution for you or your employees.

#4 Simple IRA

A possibility in the list of retirement plans for the self employed is the Savings Incentive Match Plan for Employees or SIMPLE IRA. This one is primarily designed for small businesses with fewer than 100 employees. It is a crossbreed between an IRA and a 401k. Like an IRA, this one is simple to set up and administer. Like a 401k, it has more flexibility than other IRAs but not as much flexibility as a Solo 401k, which provides higher contribution limits. Unlike both the IRA and Solo 401k, there is no Roth version of the SIMPLE IRA.

Among the retirement plans for the self employed, many employers shy away from this plan because of mandatory annual employer contributions.

Either a matching contribution of up to 3% of employee’s pay.

-or-

Contributions equal to 2% of the employee’s compensation, even if the employee does not contribute.

This applies to all employees who have compensation of at least $5,000 in any prior 2 years and are reasonably expected to earn at least $5,000 in the current year.

Employee contribution limits fall between what is allowed for an IRA and the highest limits for a Solo 401k. In 2022, the SIMPLE IRA employee limit is $14,000 or $17,000 for those age 50 or older. There is no limit on employer matching contribution if using the 2% contribution based on compensation up to $305,000 in 2022.

With the SIMPLE IRA, there are no annual tax filing requirements although annual plan details must be sent to employees. No loans are allowed from these accounts and the employer cannot maintain any other type of retirement plan.

For high earners and self employed looking to maximize contributions, the higher contribution limit of the Solo 401k makes it a more attractive choice than a SIMPLE IRA.

#5 Defined Benefit Plan

This one is starting to get away from what most people think of as retirement plans for the self employed because it resembles (and is often called) a pension or qualified-benefit plan. Both the employees and employer follow a formula to calculate retirement benefits before reaching retirement age. The other retirement plans for the self employed receive benefits based on investment earnings. Because employers do not have a crystal ball, poor returns on investments made to a defined benefit plan can result in a funding shortfall with employers legally required to make up the difference.

The term pension is often used because a defined benefit plan pays benefits based on factors such as length of employment and salary history. A surviving spouse can be entitled to the benefits if the employee passes away. Benefits are typically distributed as fixed-monthly payments like an annuity or in one lump-sum payment. The employer or a designated financial planner is responsible for making investment decisions and managing the plan’s investments. The employer is responsible for all the investment and planning risks.

The employer typically funds the plan by contributing a percentage of the employee’s pay into a tax-deferred account. If the plan allows, employees may also make contributions.

Which Self Employed Retirement Plan is Best for Me?

Now you know about the several retirement plans for the self employed that include business owners, independent contractors, and people who work for themselves outside of traditional employment. You also know that these come with very different contribution limits and benefits.

It’s important for the self employed and others working in the gig economy to choose the type most suitable for their needs and follow IRS rules for contributions. There is also IRS paperwork to qualify the plan and keep it up to date.

You want to make a decision based on what works best for your needs today, tomorrow, and during retirement. There are key factors that you should consider:

  • Do you want to make contributions as an employer, an employee, or both?
  • How much do you want to contribute this year and every year until retirement?
  • Must you have employees and contribute to their retirement, or can you run the business yourself and with contract labor?
  • Do you want your business to make contributions for both you and your spouse?
  • Do you want to make only tax-deferred contributions, or do you want the option to also make contributions to a tax-free Roth account?
  • How much work do you want to put into opening and maintaining your retirement account?

And maybe most importantly…

How Much Can a Self Employed Person Put Away for Retirement?

Being self employed has plenty of perks, from choosing your own hours to working in your pajamas. But one perk you may miss from working for an employer is having a retirement plan through work. It’s on your shoulders to determine how much you should be saving towards retirement and how much you can save.

Retirement plans for the self employed come with several different contributions limits that range from $6,000 with an SDIRA if you’re younger than age 50 up to $67,500 with a Solo 401k if you are age 50 or older. That means $67,500 is the most you can save in a tax-advantaged Solo 401k account or $61,000 if you are not yet 50.

Along with that, you need to decide how you want to live during your retirement years. Pensions are mostly a thing of the past and Social Security typically replaces only about 40% of only your pre-retirement income. You need to be saving a nest egg for yourself. How much to save is a very personal question.

If you want to just get by in retirement and will have sufficient Social Security income, some experts say you can probably get by with a nest egg that replaces 45% of your pre-retirement income. If you want to have some wealth during retirement and know that you’ll be able to live well, many experts recommend saving enough to cover 80% to 90% of your preretirement income.

But you still need to know where you are beginning from. Only you can decide how much you need and when but a general rule of thumb that covers a lot of people is:

  • By age 30: The equivalent of your current annual salary.
  • By age 40: Three times your annual salary.
  • By age 50: Six times your annual salary.
  • By age 60: Eight times your annual salary.
  • By age 67 (the age when you can start collecting full Social Security benefits): 10 times your annual salary.

Setting Up Your Self Employed Retirement Plan

Setting up a Solo 401k retirement plan is easy and allows for tax-deductible contributions much larger than an IRA or employer 401k. Plus it puts you in control with access to a world of alternative investment options.

Start where you are. Use what you have. Invest in what you want. We help get your retirement funds into your control — where they belong!

Have questions before moving forward? Chat with an expert!

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