Retirement Options For the Self-Employed

Being your own boss is great. You get flexibility and the ability to pursue the things you care about. But as the boss, you also have to deal with all the administrative and financial details an employer might typically take care of—like choosing the right retirement plan.

Though it may require a little more action on your part, there are different kinds of self-employed retirement plans to explore. In fact, some self-employed retirement plans actually have high contribution limits and tax benefits.

And it’s a good thing too, since more people than ever are self-employed or starting their own businesses. According to Fresh Books third annual self-employment report annual self-employment report, 27 million Americans are expected to leave the traditional workforce for self-employment in the next two years.

So what does retirement for self-employed people look like? Well, a little like retirement for the traditionally employed. The general rules of thumb still apply: You can calculate how much you’ll need to save for retirement based on your current age and when you plan to retire.

No matter what your age, it’s a good idea to do the math now, so you can hypothetically see how much money you could be contributing to your retirement and whether you’re on track for your age and retirement goals.

Self-Employed Retirement Plans

In some ways, self-employed retirement plans aren’t too different from regular retirement plans. Certainly, the principles of retirement are the same: set aside money now to use in retirement—ideally providing an income when it’s time to retire.

The most common retirement savings plan, though, is a 401(k), but a 401(k) is, by definition, an employer-sponsored retirement account. For those who are self-employed that’s not an option.

The IRS breaks down a number of retirement plans for the self-employed or for those who run their own businesses, but we’ll lay out the basics here for you to start thinking about.

Traditional or Roth IRA

One of the most popular self-employed retirement plans is an IRA—or an individual retirement account. Anyone can open an IRA either with an online brokerage firm or at a traditional financial institution. And if you’re leaving a regular job where you had an employer-sponsored 401(k), then you can roll it over into an IRA.

If you meet eligibility requirements, you can contribute up to $6,000 annually to an IRA, with an additional $1,000 catch-up contribution allowed for people over 50 years old. (These limits are for 2022—the IRS does adjust them from time to time.)

The main difference between a traditional vs. Roth IRA is when the taxes are paid. In a traditional IRA, the contributions you make to your retirement account are tax-deductible when you make them, and the withdrawals during retirement are taxed at ordinary income rates. With a Roth IRA, there are no tax breaks for your contributions, but you’re not taxed when you withdraw.

Choosing which IRA makes sense for you can depend on a few factors, including what you’re earning now vs. what you expect to be earning when you retire. Additionally, you can only contribute to a Roth IRA if your income is below a certain limit : For 2022, that’s less than $214,000 adjusted gross income (AGI) for a person who is married filing jointly, and less than $144,000 for a person who is filing as single.

Solo 401(k)

A solo 401(k) is a self-employed retirement plan that the IRS also refers to as one-participant 401(k) plans . It works a bit like a regular employer-backed 401(k), except that in this instance you’re the employer and the employee.

For 2022, you can contribute $20,500 (or $27,000 if age 50 or over) in salary deferrals as you would normally contribute to a standard 401(k). Then, as the “employer”, you can also contribute up to 25% of your net earnings, with additional rules for single-member LLCs or sole proprietors. Total contributions cannot exceed a total of $61,000.

From there, it works more or less like a regular 401(k): the contributions are made pre-tax and any withdrawals or distributions after age 59.5 are taxed at the regular rate. You can also set up the plan to allow for potential hardship distributions under specific circumstances, like a medical emergency.

You can not use a solo 401(k) if you have any employees, though you can hire your spouse so they can also contribute to the plan (as an employee; you can match their contributions as the employer). 401(k) contribution limits are per person, not per plan, so if either you or your spouse are enrolled in another 401(k) plan, then the $61,000 limit per person would include contributions to that other 401(k) plan.

A solo 401(k) makes the most sense if you have a highly profitable business and want to save a lot for retirement, or if you want to save a lot some years and less others. You can set up a solo 401(k) with most wealth management firms.

Simplified Employee Pension (or a SEP IRA)

A SEP IRA is an IRA with a simplified and streamlined way for an employer (in this case, you) to make contributions to their employees’ and to their own retirement.

For 2022, the SEP IRA rules and limits are as follows: you can contribute up to $61,000 or 25% of your net earnings, whichever is less. As is the case with a number of these retirement for self-employed options, there is a cap of $305,000 on the compensation that can be used to calculate that cap. You can deduct your contributions from your taxes, and your withdrawals in retirement will be taxed as income.

A key difference in a SEP vs. other self-employment retirement plans is this is designed for those who run a business with employees. You have to contribute an equal percentage of salary for every employee (and you are counted as an employee). That means you can not contribute more to your retirement account than to your employees’ accounts, as a percentage not in absolute dollars. On the plus side, it’s slightly simpler than a solo 401(k) to manage in terms of paperwork and annual reporting.

SIMPLE IRA

A SIMPLE IRA (which stands for Savings Incentive Match Plan for Employees ) is like a SEP IRA except it’s designed for larger businesses. Unlike the SEP plan, the employer isn’t responsible for the whole amount of an employee’s contribution. Individual employees can also contribute to their own retirement as salary deferrals out of their paycheck.

You, as the employer, have to simply match contributions up to 3% or contribute a fixed 2%. This sounds complicated, but the point is it’s designed for larger companies, so that you can manage the contributions to your employees’ retirement plans as well as your own. The trade-off, however, is that the maximum contribution limit is lower.

You can contribute up to $14,000 to your SIMPLE IRA, plus a catch-up contribution of $3,000 if you’re 50 or over. And your total contributions, if you have another retirement employer plan, maxes out at $20,500 annually.

There are a few other restrictions: If you make an early withdrawal before the age of 59 ½ , you’ll likely incur a 10% penalty much like a regular 401(k); do so within the first two years of setting up the SIMPLE account and the penalty jumps to 25%. (There is also a SIMPLE 401(k) that does allow for loan withdrawals, but requires more set-up administrative oversight on the front end.)

Defined Benefit Retirement Plan

Another retirement option you’ve probably heard a lot about is the defined benefit plan, or pension plan. Typically, a defined benefit plan pays out set annual benefits upon retirement, usually based on salary and years of service.

For the self-employed, your defined benefit has to be calculated by an actuary based on the benefit you set, your age, and expected returns. The maximum annual benefit you can set is currently the lesser of $245,000 or 100% of the participant’s average compensation for his or her highest three consecutive calendar years, according to the IRS.
Contributions are tax-deductible and your withdrawals during retirement will be taxed as income. And, if you have employees, then you typically must also offer the plan to them.

Defined benefit plans guarantee you a steady stream of income in retirement and with no set maximum contribution limit, if you’re earning a lot (and expect to keep earning a lot through retirement), they may be a good way to save up money.

These self-employed retirement plans can, however, be complicated and expensive to set up and require ongoing annual administrative work. Not every financial institution even offers defined benefit plans as an option for an individual. You’ll also have to be committed to funding the plan to a certain level each year in order to achieve that defined benefit—and if you have to change or lower the benefit, there may also be fees.

Other Retirement Options for the Self-Employed

While these are the most common self-employed retirement account options and the ones that offer tax benefits for your retirement savings, there are other options self-employed individuals might consider, like a profit-sharing plan if you own your own business.

Plus, don’t forget: You also have Social Security funds in retirement. Full retirement age for Social Security is considered 67 years old.

The IRS does offer what it calls annual check-ups to check on your retirement account and to go through a checklist of potential issues or fixes. However, you may want some additional human guidance, especially if you have specific questions.

The Takeaway

When you’re an entrepreneur or self-employed it can feel like your options are limited in terms of retirement plans, but in fact there are a number of options open, including various IRAs and a solo 401(k).

Looking to open a new retirement account? SoFi Invest® offers traditional, Roth, and SEP IRAs. Plus, you’ll get access to a broad range of investment options, member services, and our robust suite of planning and investment tools.

Find out how to save for retirement with SoFi Invest.