Retirement Plans for Self-Employed: What to choose

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You know you should be stashing money away on a regular basis, but anyone who’s working for themselves knows earnings can vary drastically month to month.

Also, you're not sure what the best retirement plans for self-employed individuals are.

So, what’s a busy entrepreneur with an inconsistent income and no time to research retirement plans to do? Read on!

According to the Internal Revenue Service, self-employed individuals and regular employees have many of the same retirement plan options. And similar retirement plan features exist regardless of employer status.

Best Retirement Plans for Self-Employed 3

For example:

Money can grow tax-deferred
No set annual required contribution amount
Low-cost plan set-up
Available catch-up contributions
Early withdrawal penalties may apply

There are six accounts business owners and self-employed individuals can choose from to meet their retirement savings needs.

The first three are specifically designed for just those engaging in self-employment. The last three, while sound options, may have features less advantageous than the preceding choices.

Options include:

SEP IRAs
SIMPLE IRAs
Individual 401(k)s
Defined Benefit Plans
Traditional IRAs
Roth IRAs

Keep reading for further details and the pros and cons of each retirement savings account.

Saving for Retirement as an Entrepreneur

Don’t delay in setting up a plan because you think time is on your side.

The longer you wait to start setting money aside, the more you'll likely need to contribute overall to meet your financial retirement goals.

Financial retirement planning contains a few essential terms investors need to know before making a plan selection.

Knowing these terms will lead to a greater understanding of the best retirement plans for business owners and the importance of starting a plan today.

Basic Definitions

Contribution – A dollar amount (pretax or after taxes) placed in a retirement plan account. Amounts may be limited based on the plan participant’s income and prior contributions.

Tax Deductible Plan – A plan allowing the participant to lower the tax liability (amount owed in taxes) by reducing the taxable income amount.

Taxable Income – The amount used by the Internal Revenue Service to determine how much tax is owed.

Simplified Employee Pension Individual Retirement Account (SEP-IRA)

The SEP-IRA is an easy to start, low administrative cost tax-deductible plan which comes with several advantages for self-employed workers. And you decide the annual contribution amount which can change from year to year.

If you have a low-income year, you can decide not to make contributions at all.

In 2022, you can contribute the lesser of – up to 25% of your annual earnings or up to $61,000.

Tax credits of up to $500 per year for each of the first three years for the cost of starting the plan are available to eligible plan participants.

Provide a completed Form 5305 – SEP to a retirement plan professional at a financial institution that sponsors SEPs.

Not sure how much to contribute? Use this nifty SEP-IRA retirement plan calculator.

Additional Considerations:

Plan participants can withdraw money at any time, however, such withdrawals are taxable unless rolled over to another retirement plan
Plan participants cannot take loans from their SEP-IRAs

Savings Incentive Match Plan for Employees (SIMPLE IRA)

The SIMPLE IRA works for self-employed individuals and small business owners who meet specific eligibility requirements.

Plan requirements relate to company size, earnings per employee, and other retirement plans.

You have no more than 100 employees
You've earned at least $5000 in the most recent calendar year and expect to earn at least $5000 in the current year
You cannot currently have another retirement plan

The annual contribution limit for 2022 is $14,000 plus an additional $3,000 if you are over 50.

Additional Considerations:

The annual contribution limit is lower than other plans
Plan participant loans are not permissible
You may not use funds as collateral for other loans

Be sure to use Form 5305 – SIMPLE to set up the retirement plan at a financial institution or investment company.

An IRA calculator can lay the groundwork for your investment plan. Use it to set investment goals keeping in mind expected investment return along with tax and inflation rates.

Protect Your Retirement Savings from Inflation

Individual or Solo 401(k)

If you participated in a company-sponsored 401k plan in the past, you might recall that such plans have a vast amount of investment options.

The Individual 401(k) also known as the solo 401(k) or self-employed 401(k) has a varied selection which will differ by the investment company or account provider, i.e., T. Rowe Price vs. Fidelity vs. Rocket Dollar.

T. Rowe Price offers participants a choice of over 100 mutual funds.

While Rocket Dollar has more than 70 partners for their self-directed Solo 401(k) accounts.

Not interested in setting up your 401(k) online? Fidelity has Investor Centers across the country where you can meet with an investment representative in person.

The maximum annual contribution for 2022 is the lesser of $61,000, and $67,500 for those 55 and older, or 100% of compensation.

Additional Considerations:

The Individual 401(k) is unique in that unlike the SIMPLE IRA and SEP IRA; it can be used to cover both one-person business owners and his/her working spouse.
- IRA vs. 401(k): How they differ and where to invest 1st

Defined Benefit Plans

This type of plan provides a fixed, pre-established benefit at retirement, using a formula to calculate your benefits in advance of retirement.

The key here is that with a defined benefit plan, the benefit is guaranteed regardless of the investment performance in the years leading up to retirement. Think pension.

Pros:

Available for any size business
Can have other retirement plans
Participant loans are available

Cons:

Most costly type of plan to establish and maintain
Most administratively complex retirement plan option
Additional taxes apply if minimum contribution amount is not met or if excess contributions are made

Traditional and Roth IRAs

Traditional IRAs allow for investing of pretax income on a tax-deferral basis meaning taxes are due upon withdrawal.

Roth IRAs differ in that you make contributions based on the money you've already paid taxes on, allowing it to grow tax-free.

These plans are usually used by individuals who are leaving an employer-sponsored plan and rolling over their old 401(k) to a custodian like Vanguard or Edward Jones.

Individuals may continue adding to the contributions originally made under the employer-sponsored plan.

Traditional IRA

Pros:

The plan is open to anyone with earned income (and their nonworking spouse filing jointly)

Cons:

Maximum annual contribution amount for 2022 is $6,000 (if over 50 years of age then $7,000)
Contribution limitations based on age (ineligible after 70 ½ or older)
The ability to take contribution related tax deductions are limited by your tax filing status and modified adjusted gross income

Roth IRA

Pros:

Plan is open to anyone with earned income (and their nonworking spouse filing jointly)
Ability to pay income taxes today on retirement funds instead of when they are withdrawn during retirement

Cons:

Maximum annual contribution amount for 2022 is $6,000.00 (if over 50 years of age then $7,000.00)
Contribution limits are based on your tax filing status and income
Contributions are not tax-deductible

The best retirement plan is the one you open.

Self-employed individuals and business owners must take the initiative in retirement planning and can do so simply with the options listed above and available on the open marketplace.