Retirement Accounts for Self -Employed Individuals

LAST REVIEWED Dec 13 2019 9 MIN READ

By The Human Interest Team

As a self-employed individual, you get the flexibility of choosing your own work hours and schedule. However, since there is no employer involved, you need to plan for your retirement on your own. No matter how difficult it is, you should set aside some money for the future. Once you determine the amount you need to save each year, you can decide how and where to invest that money.

Which Retirement Plan Is Best for the Self-Employed?

The main retirement accounts for self-employed individuals include the following:

  • Traditional and Roth Individual Retirement Accounts (IRAs).

  • A solo 401(k) plan.

  • A Simplified Employee Pension or SEP IRA.

  • A Savings Incentive Match Plan for Employees or SIMPLE IRA.

  • A defined benefit plan.

Traditional and Roth IRAs

If your annual savings are below $6,000, a traditional IRA or a Roth IRA might be your best option. If you worked for a company previously, you can rollover your existing 401(k) account to an IRA. The contribution limits in an IRA are relatively lower than other options, but you stand to get tax benefits. The contribution limit for 2020 is $6,000 (same as 2019). You can make an additional contribution of $1,000 if you are 50 years or older.

In the case of a traditional IRA, you qualify for a tax deduction for the number of contributions made during the year, but the withdrawals are taxable and added to your taxable income. It’s just the opposite in the case of a Roth IRA: You contribute from your post-tax income, and the withdrawals are tax-free.

Both of these are individual retirement plans. If your employees want to set up either of these accounts, they can do so through a brokerage firm.

Solo 401(k): The Best Retirement Plan for Self-Employed Without Employees 

If you do not have any employees other than your spouse, a solo 401(k) plan might be your best choice.

The contribution limit for a solo 401(k) account is $57,000 for 2020. If you are 50 years or older, you can contribute an additional catch-up amount of up to $6,000 to the extent it does not exceed your total annual income.

You can make two contributions in the capacity of an employee and an employer. The contributions made as an employee work the same way they do in a traditional 401(k) plan set up by an employer. You can contribute up to the entire amount of your compensation to the extent it does not exceed $19,500 (plus a catch-up contribution of $6,000). As an employer, you can contribute another 25% of your compensation.

The tax implications of a solo 401(k) plan are also similar to those of a traditional 401(k) plan. You can deduct the contributions from your taxable income, but the distributions are taxable.

You do not qualify for a solo 401(k) account if you have employees. The only exception to this rule is hiring your spouse.

You can set up a solo 401(k) account online with a brokerage firm. Once your account balance reaches $250,000, you must file documents with the Internal Revenue Service (IRS).

SEP IRA: Best Pension Options for Self-Employed

A SEP IRA may be suitable if you are self-employed or you run a small business with a modest number of employees.

For 2020, you can contribute up to one-fourth of your compensation or net earnings, subject to a limit of $57,000. As an employer, you are also required to contribute to your employees’ accounts, including yourself. The contribution must be an equal percentage of salary. For example, if you contribute 12% of your salary, you must also contribute 12% of each employee’s salary to their respective accounts.

You can deduct your contributions from your taxable income for the year. However, distributions are subject to taxes.

Setting up a Pension Self Employed: You can set up a SEP IRA with a bank or other financial institution. You need not contribute to a SEP IRA every year. However, making equivalent contributions to your employees’ accounts can be a burden, especially if you have a high number of employees.

SIMPLE IRA

If you have a large business with up to 100 employees, a SIMPLE IRA may be the right retirement plan. In 2020, you can contribute an amount of up to $13,500 (increased from $13,000 in 2019). You can also contribute another $3,000 if you are 50 years or older. Your total contributions, including those to an employer plan, cannot exceed $19,500.

Unlike with a SEP IRA, you are not required to contribute to your employees’ accounts in equal percentage of salary. However, you may be required to match your employees’ contributions. The matching contributions can either be up to 3% of your employees’ compensation or fixed contributions of 2% for each employee. If you choose to make fixed contributions, your employees need not make any contributions from their end to qualify for your matching contributions.

Your contributions qualify for deduction from your taxable income. You can deduct the amount contributed to employee accounts as business expenses.

You can set up a SIMPLE IRA with a bank or other financial institution any time between January 1 and October 1. If you become eligible for the plan after October 1, you should set the plan up as soon as feasible after starting your business.

Early withdrawals, such as those made before you reach 59 ½ years, are charged income tax and a penalty of 10%. The withdrawal penalty increases to 25% for accounts less than two years old.

Defined Benefit Plan

You may want to choose a defined benefit plan if you meet all the following conditions:

  • You do not have any employees.

  • Your income is significant.

  • You want to put aside a large sum of money for retirement on a regular basis.

The contribution limit for a defined benefit plan depends on several factors, including your age, the amount of retirement benefit you want, and your desired return on investment.

Contributions made to a defined benefit plan are tax-deductible, but you will need an actuary to determine your deduction limit. Withdrawals are subject to income tax.

In addition to the above-mentioned plans, you may also consider profit-sharing plans and money purchase plans. Our experts can help you choose and set up the right retirement plan. Contact us today for a free consultation.

We believe that everyone deserves access to a secure financial future, which is why we make it easy to provide a 401(k) to your employees. Human Interest offers a low-cost 401(k) with automated administration, built-in investment advising, and integration with leading payroll providers.

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