Retirement Planning for Independent Contractors

By Ashley Kilroy · March 29, 2022 · 10 minute read

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Retirement Planning for Independent Contractors

There are several retirement plans for independent contractors, consultants, and freelancers that can help you build up a nest egg for retirement, including a SEP IRA, traditional or Roth IRA, and solo 401(k).

While you may have to do some research to determine the best options for your needs, there’s a benefit to having the freedom to invest your money the way you want, without being constrained by an employer-sponsored plan. That said, since you can’t count on the convenience of a larger company plan, it’s important to be proactive.

Fortunately, these accounts are easy to understand — and these days they’re typically straightforward to set up. Here are some retirement savings options and how they can help you, as a contractor or freelancer, plan for a well-funded future.

Types of Retirement Plans for Independent Contractors

There are a number of tax-advantaged independent contractor retirement plans worth considering — even one that could be considered an independent contractor 401k! However, there is no one-size-fits-all solution, so it’s wise to weigh all of your options.

Bear in mind: Once you’ve set up your chosen retirement plan — e.g. an IRA for independent contractors or another option — you’ll need to select the investments that will populate your account. In other words, you’ll build a tax-advantaged portfolio that may include mutual funds, exchange-traded funds (ETFs), target funds or other investments.

All retirement plans come with rules and restrictions. If you need additional guidance, speak with a financial planner who can answer your questions.

Roth IRA

What is the best IRA for independent contractors? There are two types of individual retirement accounts or IRAs that are suitable for independent contractors, consultants, and freelancers: a Roth IRA and a traditional IRA. These accounts have some similarities: Both types of IRAs require you to have earned income. Also, you can’t contribute more than your taxable income. So, if you make $5,000 per year, you can only contribute this amount.

In terms of contribution limits: For 2021 and 2022, both types of IRA let you contribute up to $6,000 per year, plus an extra $1,000 if you’re over 50 years old (often called the catch-up contribution).

Now for some differences:

Tax treatment

With Roth IRAs, you pay income taxes on the money you deposit (so contributions are considered after-tax). Your money grows tax free. And you don’t have to pay income taxes on the money you withdraw in retirement; Roth withdrawals are tax free.

Early withdrawal rules

If you need to take a distribution before retirement, Roth IRA contributions can be withdrawn at any time without tax or penalty, for any reason at any age. However, this only applies to the funds you contributed, i.e. your actual deposits, not any earnings.

Investment earnings on those contributions can typically be withdrawn, tax-free and without penalty, once the investor reaches the age of 59 ½, as long as the account has been open for at least a five-year period.

Income limits

Also, Roth IRAs come with certain income limits, meaning you must make less than a certain amount to be eligible to contribute to a Roth. For example, for folks that file their taxes as a single head of household, you must have an adjusted gross income (AGI) less than $129,000 in 2022 to contribute the full amount. Folks married and filing jointly must have an AGI of less than $204,000 to contribute the full amount.

If your AGI is higher (e.g. up to $144,000 for single filers; up to $214,000 for married filing jointly), you may be able to contribute a reduced amount. Be sure to consult IRS rules.

Required Minimum Distributions (RMDs)

In most cases, you do not have to take required minimum distributions on money in a Roth IRA account. However, for inherited Roths, IRA withdrawal rules mandate that you do take RMDs.

Traditional IRA

A traditional IRA is quite different from a Roth IRA in terms of its tax treatment, income limits, and withdrawal rules.

Tax treatment

First, the money you save in a traditional IRA is considered pre-tax, meaning your contributions are tax deductible. However, when you take distributions in retirement, a.k.a. withdrawals, you will have to pay ordinary income taxes on that money (unlike a Roth, where withdrawals are tax free).

Early withdrawal rules

Also, if you decide to take a distribution from your IRA before you reach age 59 ½, which qualifies as an early withdrawal, you will have to pay a 10% penalty in addition to any taxes you owe. However, in some cases you may be able to withdraw or borrow money without paying a 10% penalty.

Required Minimum Distributions (RMDs)

Although you can take withdrawals from your IRA any time after age 59 ½, you are required to start taking withdrawals the year you turn 72. This is similar to the RMD rules for 401ks. After that, you have to take distributions each year, based on your life expectancy. If you don’t take the RMD, you’ll owe a 50% penalty on the amount that you did not withdraw.

Because RMDs can be complicated, and the penalty for any mixups or mistakes can be high, you may want to consult a professional.

Simplified Employee Pension or SEP IRA

For independent contractors who want or intend to save more than the contribution limits for traditional and Roth IRAs above, a SEP IRA could be ideal. A SEP IRA plan is less expensive to set up, and can also work for companies with a few employees.

Similar to a traditional IRA, contributions to a SEP IRA are tax-deductible, and when you take distributions in retirement, you must pay ordinary income on the total distribution amount.

But the amount you can save is a big selling point: With a SEP IRA, you can contribute up to 25% of the net profits of your business per year or $61,000, whichever is less. Like other retirement plans for independent contractors, a SEP IRA sets a compensation limit of $305,000 for contributions.

As with a traditional IRA, you pay a 10% penalty for any withdrawals you make prior to age 59 ½, unless one of the usual exceptions applies — death, disability, medical expenses, and so on. It’s easy to open a SEP with most financial institutions — including SoFi Invest®.

In more good news: Contributing to a SEP IRA doesn’t prevent you from also saving in a Roth IRA, as long as your income is under the Roth income limits.

To establish a SEP IRA, you must choose a financial institution that can act as a trustee and keep the plan assets safe. Your financial insulation should be able to walk you through the next steps.

Savings Incentive Match Plan for Employees or SIMPLE IRA

A Savings Incentive Match Plan for Employees, also known as a SIMPLE IRA, is intended for businesses with fewer than 100 employees.

If you’re your own boss and self-employed, you can set one up for yourself.

SIMPLE IRAs are relatively easy to put in place, since they have no filing requirements for employers. Employers cannot offer another retirement plan in addition to offering a SIMPLE IRA.

The business is not solely responsible for all contributions with a SIMPLE IRA. The employees can also contribute a portion of their salary to their accounts.

The employer’s contribution

When an employer sets up a SIMPLE IRA plan they are required to contribute to it for their employees. There are two options:

•   The employer can make matching contributions of up to 3% of an employee’s compensation

•   They can make a nonelective contribution of 2% for each eligible employee, up to an annual limit of $305,000 in 2022.

If the employer chooses the latter, they must contribute to their employees’ accounts, even if the employees don’t contribute themselves (i.e. the contributions are nonelective). Contributions to employee accounts are tax deductible.

The employee contribution

In 2022, eligible employees can make SIMPLE IRA contribution limits up to $14,000. Those over age 50 can contribute an extra $3,000 in catch-up contributions (for a total of $17,000).

Like other retirement plans for independent contractors, there is a 10% early withdrawal penalty if you take money out of your account before you reach age 59 ½. If you take out money within the first two years of opening the plan, the penalty increases to 25%.

Solo 401k

Wondering if there’s an independent contractor 401k? Effectively yes: Solo 401k plans are similar to employer-sponsored 401ks, except they are intended for one participant. Usually, these plans are limited to independent contractors. However, their spouses might qualify for participation if they work part-time for you.

In 2022, you can contribute up to $61,000 per year with a catch-up contribution of $6,500 if you’re 50 or older. However, with a solo 401k, you will be treated as the employee and employer. Therefore, you can contribute up to $20,500 as an employee. As the employer, you can contribute up to 25% of your adjusted gross income to $61,000.

As long as you net profits as an independent contractor and don’t have other employees you are likely eligible for a solo 401(k).

Choosing the Right Plan for You

All independent contractors have different financial goals and situations. Therefore, different plans may be more suitable than others.

When it comes to getting your retirement on track, it’s important to weigh the various benefits and drawbacks of each type of plan.

For example, a solo 401k has higher potential tax savings and contributions limits than an IRA since you can contribute significantly more to this account. Also, solo 401ks come with features you may find with employer-sponsored 401k plans, such as the ability to take loans ($50,000 or 50% of your account balance, whichever is less) Also, you have a Roth option which gives you the option to pay your taxes now instead of during retirement.

On the other hand, if you plan to grow your business in the future and add employees, a SEP IRA may make the most sense. Switching from a solo 401k to a SEP can be a big headache. So starting with a SEP IRA may be the best solution for employee growth. SEP IRAs let you add employees. However, SEP rules state that you must contribute an equal percentage to their retirement accounts like yours. So, this is an extra consideration when planning for the future.

Also, speaking with a financial professional can help you pinpoint the best solution for the long haul.

Investing for Retirement With SoFi

There are many different retirement plans for independent contractors. However, it’s up to you to determine what makes the most sense for your needs and long-term goals. You may want to review contribution limits, eligibility requirements, and distributions rules to find the most suitable plan for your retirement savings — whether that’s a traditional IRA, Roth IRA, SIMPLE IRA, SEP IRA, or solo 401k.

Traditional and Roth IRAs have lower contribution limits than the other plans, but they may be simpler to manage. SIMPLE and SEP IRAs allow you to save more of your pre-tax income (and thus reduce your taxable income) — and these accounts can be used if you have additional employees besides yourself. A solo 401k is one you managed as an independent contractor, but it can offer features that are similar to a company plan.

Whichever route you choose, don’t wait. As an independent contractor, consultant, freelancer, or small business owner, your future is in your hands. Fortunately, it’s easy to open an Active Invest account with SoFi Invest®, and start to grow your retirement savings with a Roth, SEP, or traditional IRA account. With SoFi Invest, you can access a wide range of investment options, as well as member features, and a comprehensive array of planning and investment tools.

Also: SoFi members have complimentary access to financial professionals who can help answer your questions. Take the next step toward a secure future today.


Can independent contractors have a 401k?

Yes. Independent contractors can open a solo 401k, designed for individuals instead of companies. This account offers a lot of the same benefits and flexibility as an employer-sponsored 401k, such as a Roth option and the ability to take out a loan.

How do independent contractors save for retirement?

Independent contractors don’t have the convenience of relying on an employer-sponsored plan. Fortunately, there are several good options for saving for retirement when you’re an independent contractor, consultant, or freelancer: including SEP IRAs, traditional IRAs, Roth IRAs, or solo 401(k)s. There can be substantial tax benefits for independent contractors who use one or more of these plans, so it’s wise to be proactive.

What is the best retirement plan for 1099 employees?

The best retirement plan for a 1099 employee depends on your unique situation and financial goals. For example, a solo 401k might be suitable for someone who wants to contribute a significant amount and capitalize on a higher tax advantage. Whereas a SEP IRA might be better for someone who wants to add employees to their business down the line.

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Photo credit: iStock/Eva-Katalin

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