Private Client Services

Self-Employed? 4 Retirement Plan Options

Posted on May 17, 2023 by

Margaret Amsden

Margaret Amsden

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Couple watching sunset on beach chairsSelf-employment comes with a lot of freedom, but it also comes with the responsibility to save for retirement. Here are four common retirement plan options for self-employed individuals and business owners to choose from. 

1. Traditional or Roth IRA

This option is first on the list because it is considered one of the easiest ways to start saving for retirement—an IRA (Individual Retirement Account) can be opened at an online brokerage within minutes. There are no special filing requirements, and an IRA can be used whether or not you have employees. Even if you have employees, they can set up and contribute to their own IRAs. If leaving a job to start a business, any money from an old 401(k) can be rolled into an IRA.  

Keep in mind there are tax deductions on contributions to traditional IRAs, but not on Roth IRAs. However, there are income limits that determine eligibility for Roth IRAs and those who earn too much will not qualify. Withdrawing from Roth IRA accounts in retirement is tax-free, which is one of the most attractive benefits of contributing to a Roth IRA. There is a limit to annual contributions to IRAs which for 2022 amounts to $6,000, or $7,000 for those over the age of 50. Early withdrawals prior to retirement can come with a hefty 10% penalty as well as having to pay income tax on the amount withdrawn. Roth IRAs do allow contributions—not earnings—to be withdrawn at any time without having to pay any penalties or income taxes, once the initial 5 year holding period has passed.  

A primary factor in choosing between traditional or Roth IRAs  tax rate, both now and in the future. If you expect to be in a higher tax bracket in retirement, it may be better to choose a Roth IRA with its future tax benefit. However, if you expect lower rates in retirement, a traditional IRA may be the preferable option.  

2. Solo 401(k) 

This option is geared toward business owners who are self-employed and have no employees except a spouse, if applicable. A solo 401(k) allows an individual to act as both the employer and the employee. In the role of the employee, you can contribute the same as you would for any other standard employer-provided 401k option. In 2022 this includes a salary deferral of up to 100% of your compensation or $20,500—whichever amount is less. In your capacity as the employer, you can make an additional contribution of up to 25% of compensation. For sole proprietors and single-member LLCs “compensation” is defined as  net self-employment income. 

The total contribution limit for 2022 is $61,000 with a bonus of $6,500 catch-up contribution for those over 50 years of age or 100% of income earned—whichever amounts to less. Like a traditional employer-offered 401(k), you can make pre-taxed contributions, but distributions made after aged 59 ½ will be taxed.  

This plan is attractive to business owners who may wish to save more when the business is doing well and less during more lean years in industries where earnings can fluctuate.  It also allows those who cannot reach the contribution cap using a SEP IRA to contribute more to the plan because of the employee deferral element.  The downside is that, like all 401k plans, there is a separate tax filing requirement that must be met annually. 

3. Simplified Employee Pension (SEP IRA)

A SEP IRA is ideal for self-employed people or small business owners with very few or no employees on their payroll. Under this retirement plan, employers must contribute an equal percentage of salary—not to be confused with receiving the same dollar amount—for each eligible employee. This can be costly for small businesses with more than just a few employees. The contribution limit for 2022 is the lesser of either $61,000 or 25% of net earnings. In 2023, the contribution limit will increase to $66,000.  

It is easy to set up a SEP IRA with online brokers that is like a traditional or Roth IRA, but it does require some additional paperwork. Despite the slight increase in paperwork, it is still considered easier to maintain a SEP IRA than a solo 401(k) since the paperwork is still minimal and does not require annual reporting to the IRS. The appeal of a SEP IRA is that it has high contribution limits and is flexible on whether you contribute annually. 

4. Defined Benefit Plan 

This is another option for self-employed individuals who do not have employees but have a high income and the desire to save a significant amount for retirement regularly. The contribution limit is calculated based on the amount that is needed to fund the benefit at the time of retirement and factors in the individual’s age and the expected investment return . This will require an actuary to calculate the allowed deduction limit, which adds another complex administrative layer. Contributions in this retirement structure are still generally tax deductible and distributions during retirement are taxed as income.  

Defined benefit plans have less options for brokerages compared to the other self-employment retirement options. While these plans provide guaranteed retirement income, they are not for everyone because they are expensive and come with high setup fees in addition to annual administrative costs. This plan mostly benefits high-income earners looking to stash large amounts of cash in their retirement fund, which is more appealing for those who are closer to retirement. 

Continue the Conversation 

There is a retirement plan out there for every type of self-employed business owner—the key is to start saving sooner than later. If you have questions about these retirement plan options, please reach out. Our Private Client Services team looks forward to helping you prepare for long-term financial health and select the best retirement savings plan. 

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Margaret Amsden

Shareholder, Private Client Services

Margaret leads the firm’s private client services group as the point person for individual, estate and succession planning tax strategies.

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