How to Approach Retirement Savings as a Self-Employed Individual

Many people fear running out of money during retirement. The key to saving enough is diversifying your investments and taking advantage of different opportunities. For people who are self-employed, the path to doing this may not seem straightforward since there are no employee-sponsored accounts to use.

However, self-employed individuals have a wide range of options when it comes to saving for retirement and can often save more than is possible with traditional employment-related qualified plans. Figuring out what option may prove best for you involves learning about all the possibilities and identifying personal goals.

With a better understanding of what you need and what is offered, you can identify the best combination of products, or plans.

Popular Defined Contribution Plans for the Self-Employed

One of the major advantages of an employee-sponsored plan is contribution matching. While self-employed individuals do not all have this advantage, there are other potential benefits to defined contribution plans for this population.

One of the most popular options is the solo 401(k), which has all the advantages of an employer-sponsored plan and some additional benefits. You can choose between traditional and Roth accounts and have access to virtually any asset class when it comes to investing. Additionally, there are no-fee options for these accounts.

In 2021, you can contribute up to $19,500 annually as an employee and up to 25 percent of company profits as an employer. Between the two, the deposit cannot be more than $58,000 annually, although people 50 and up can make an additional $6,500 catch-up contribution.

Another option is a SEP IRA, which allows you as the employer to offer retirement planning to employees. The rules of a SEP IRA are the same as a traditional IRA except that there is a $58,000 maximum annual contribution. SEP IRAs permit businesses to make employer contributions to employees, including the self-employed.

This contribution can be up to 25 percent of annual profits or the maximum, whichever is less. Many brokers offer this plan, and you will still have access to a traditional or Roth IRA. Unfortunately, the SEP IRA itself does not have a Roth option. However, you can convert all or some of your SEP IRA funds to a ROTH IRA shortly afterwards, recognizing that the converted amounts would be taxable as ordinary income in the year of the conversion.

The third option is the SIMPLE IRA, which is open to employers with 100 employees or fewer, including the self-employed. This IRA is tax-deferred like a traditional IRA with contributions up to $13,500 annually. People 50 and over can take advantage of a $3,000 yearly catch-up.

Additional Options for People Who Are Self-Employed

If you are self-employed, you can also set up a defined-benefit plan, which allows you to save even more money. The contribution limits for these accounts are based on income, years in business, and age with an annual cap of $200,000.

These plans can be difficult to set up and quite cumbersome and cost a significant amount to maintain, but the trade-off is worth it if you are contributing a lot of money. Thus, the defined-benefit plans are a great option for high earners who want to put away more money than they otherwise could.

Individuals not in this situation may want to stick to a defined contribution plan. However, if you are a high earner, it could be worthwhile to talk to an expert about the options and figure out if a defined-benefit plan makes sense.

The Best Plan to Choose for Savings While Self-Employed

The best option depends entirely on your individual circumstances. If you are the sole employee, a solo 401(k) is a great option since it gives you all the benefits of a traditional 401(k) with some added bonuses. This account lets you make both employee and employer contributions, and you can additionally create a Roth version to take advantage of tax benefits.

Not only that, but these plans give you access to a wide variety of asset classes. Also, spouses can participate in them, which is the exception to the sole employee rule. Since you can contribute the first $19,500 you earn, you can save a lot on taxes, which is beneficial if you are a lower earner or the business is a side hustle. You would need to earn much more to make the same contribution to a SEP IRA.

Notably, you are capped at $19,500 for all 401(k) accounts. Thus, if you have a 401(k) from an employer and the solo account, the combined contributions to both cannot exceed $19,500. However, you will still have the employer contribution through the solo 401(k), which can be up to 25 percent of company earnings.

If you have employees other than yourself and your spouse, the solo 401(k) is no longer an option, so you will need to think about the IRA options. Consider the growth of the company and whether you expect to continue expanding.

Also, it is important to note that you can have a traditional or Roth IRA even if you have a SEP or SIMPLE IRA. In 2021, you can contribute up to $6,000 to a personal IRA on top of what you put into a self-employed account. Thus, even if a solo 401(k) is not an option, you can still be far ahead on the retirement savings game as a self-employed person.

Originally published at https://robertryerson.me on September 10, 2021.

Robert Ryerson authored the 2016 book What’s the Deal With Identity Theft?: A Plain English Look at Our Fastest Growing Crime.

Robert Ryerson authored the 2016 book What’s the Deal With Identity Theft?: A Plain English Look at Our Fastest Growing Crime.