Retirement Plans for the Self-Employed

When you’re your own boss, enrolling in a company-sponsored 401(k) isn’t an option when it comes to saving for retirement. A pension? Probably not. But you’re in luck! You’ve still got a number of options when it comes to retirement plans for the self-employed. Here are some of the best ways that solopreneurs can boost their financial health for the future.

TRADITIONAL IRA

An IRA works similarly to a 401(k) that you would get through an employer, except that you open the account as an individual. It holds cash and investments that you purchase with your own contributions. And the amount of that contribution is generally tax-deductible. Your investments then grow tax-free. You will, however, pay ordinary income taxes on the money that you withdraw (known as a distribution) from the account during retirement.

The combined amount you can contribute to all your IRAs — traditional or Roth (more on Roth accounts in a moment) — is capped in 2021 at $6,000 annually for anyone under 50, and $7,000 annually for older IRA owners. If your earned income for the year is less than that amount, you can contribute only up to the total amount you’ve earned.

Keep in mind that you’ll be required to start withdrawing money from your IRA when you retire or reach age 70½  — whichever happens later. The IRS provides resources and worksheets that can help you determine what your required minimum distribution (RMD) is and when you need to start taking it.

ROTH IRA

Like a traditional IRA, a Roth IRA is a retirement account that holds cash and investments. But, while a traditional IRA defers taxes until withdrawal, a Roth requires you to pay taxes upfront before you make the contribution. The upside is that, at retirement age, you won't pay anything in taxes on your withdrawals. Plus, unlike a traditional IRA, a Roth IRA comes with no requirement to withdraw money you put into it on a specified timetable.

“Many investment companies offer pre-packaged plans that you can adopt for your business.”

Remember: Your total contributions to a Roth and a traditional IRA can't exceed the contribution limits set each year by the IRS. And, if your earn more than IRS-specified limits, you can’t contribute to a Roth IRA at all.

Ready to take the next step? A financial advisor can show you how all the pieces of your financial plan fit together.

Not sure if a traditional IRA or a Roth is right for you? While some advisors point to age as the deciding factor, Keith Moeller, an estate and business planning specialist with Northwestern Mutual, disagrees. “It’s not so much age as what your gross taxable income is now versus what you would expect after retirement.” In fact, he typically recommends a diversified approach in which some of your retirement savings reside in traditional tax-deferred accounts, while others sit in Roths.

SOLO 401(k)

Looking to save more than your IRA annual limits permit? Moeller notes that solopreneurs may choose to start their own retirement plans.

If you’ve worked as an employee, it’s likely that you’re familiar with plans like the 401(k). A solo 401(k) — sometimes called a solo(k), uni-k, or one-participant k — is simply a 401(k) plan that’s operated and used by a single person.

As a business owner, you can open your own 401(k) in which you’re both the employer and the employee. That dual role means you can make employee and employer contributions to the plan.

Furthermore, you may be able to create a Roth 401(k) plan. These plans can be particularly beneficial if you love contributing to a Roth IRA but can’t because you exceed the income limitations. With a 401(k) and Roth 401(k), there’s no income limitation for participants.

Additionally, you can contribute far more to a Roth 401(k) plan than you can to a Roth IRA. The combined amount you can deposit into a traditional 401(k) and Roth 401(k) for 2021 is $19,500. And, if you’re age 50 or older, you can tack on an extra $6,500 to that amount. As an employer, you can contribute even more.

As with a traditional IRA, you’ll need to start taking required minimum distributions from your traditional or Roth 401(k) when you reach a certain age.

SEP / SIMPLE IRA

When looking at options for your business’ retirement plan, consider also the Simplified Employee Pension (SEP IRA) and Savings Incentive Match Plan for Employees (SIMPLE IRA). A 401(k), SEP IRA and SIMPLE IRA have a number of differences, but the majority of them vanish if your plan covers just one employee — you. In the end, the biggest difference boils down to the annual contribution limits.

In 2021, a SEP IRA allows you to contribute $58,000 or up to roughly 25 percent of your business profits — whichever is less. A SIMPLE IRA, meanwhile, permits you to make both an employee contribution of up to $13,500 (or $16,500 if you’re 50+) and an employer contribution whose size is a percent of your business profit.

Once again, you’ll need to start taking required minimum distributions from your SEP or SIMPLE when you reach a certain age.

For all these self-employed retirement plans, Moeller shares that many investment companies offer pre-packaged plans that you can adopt for your business. “Once you adopt the plan,” he says, “you develop the accounts, look at the risk profile, determine how much you’re going to put into the plan, and make contributions that are invested based on your risk profile.”

When you’re a one-person show, saving for retirement is solely your job. But you have a number of financial options from which to choose to provide an invaluable benefit to your very best employee — yourself.