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5 Retirement Plan Options for the Self-Employed

If you are self-employed or own a small business, worry not!

Today, I will discuss the five main retirement options that you can look into. They include; an IRA (traditional or Roth), a Solo 401(k), a SEP IRA, a SIMPLE IRA or a defined benefit plan.

Self-employment comes with some measure of freedom. However, this does not mean that you are exempted on saving for retirement.

Being self-employed requires self-discipline when it comes to saving for retirement. Unlike an employee who might access 401(k), those who are self-employed are often on their own.

The first step is to be aware of the amount of money you need to save for retirement. You may check online and find various retirement calculators to make this easier. Once you determine your yearly savings, it will be easier to determine the best account for you.

The second step entails determining where to put your money. The good news is that below is detailed information that will help you determine what is best for you;

1. Traditional or Roth IRA

Suitable for: This option is best for the individuals who are just starting out. In the case that you just left your job to start a business, you can roll your old 401(k) into an IRA.

Contribution limit: An IRA contribution limit in 2021 is $6,000 and $7,000 for those who are age 50 and above.

Tax advantage: Expect a tax deduction on contributions to a traditional IRA. For Roth IRA, the deductions are not immediate, but in retirement, the withdrawals are tax-free.

Employee element: For this option, there is no employee element; meaning that in case you have employees, they can set up and contribute to their individual IRAs.

Getting started: To get started, you can open an IRA at an online brokerage.

Further details:

 The IRA option is regarded as one of the easiest ways for those who are self-employed to begin saving for retirement. It does not require special filing requirements and you can utilize it whether you have employees or not.

 The challenging part may be deciding the type of IRA to open. From various research, it appears that the tax treatment of a Roth IRA might be the best if it’s early days for your business; this assumes that you are not making much money. If this is the case, there is a possibility of having a higher tax rate in retirement when you will be able to get that money out tax free.

N/B: There is an income limit for eligibility of the Roth IRA; individuals who earn too much cannot contribute.

2. Solo 401(k)

 Suitable for: It is best for a self-employed individual who does not have employees; except a spouse if applicable.

Contribution limit: As of 2020, the contribution limit was set at $57,000 plus an additional $6,500 catch-up for those who are age 50 and above; or 100% income: whichever is less. As of 2021, its $58,000 plus $6,500 catch-up contribution or 100% earned income, whichever is less. So as to understand these contribution limits, assume that you are two people; an employer (yourself) and an employee (yourself);

  • As an employee, you enjoy the same benefits that comes with a standard employer-offered 401(k); this entails salary deferrals of up to 100% of your compensation or $19,500 (plus that $6,000 catch-up contribution, if eligible), whichever is less.
  • As an employer, you can contribute an additional 25% of compensation.
  • Sole proprietors and single-member LLCs are allowed to contribute 25% of net self-employment income; this is your net profit less half your self-employment tax and your plan contributions.
  • As of 2020, $285,000 was the limit on compensation that was used to factor your contribution; this limit has since increased to $290,000 in 2021.

Tax advantage: This plan comes with a tax advantage that is similar to a standard employer-offered 401(k) where you make contributions before tax and distributions after age 59½ are taxed.

Employee element: This Solo 401(k) option does not accept contributions if you have employees. However, you can hire your spouse so that s/he contributes to the plan. In this case, your spouse can make a contribution up to the standard employee 401(k) contribution limit, you can include in the employer contributions an additional $58,000 total in 2021, plus catch-up contribution if eligible. This actually doubles what you can save as a couple.

 Getting started: Open a solo 401(k) at any online brokers. It is necessary to file paperwork with IRS annually once you have more than $250,000 in your account.

Further details:

Referred to as a “one-participant 401(k)” by the IRS, this plan is ideal for individuals who intend to have lots of savings for retirement or those who want to save a lot in years to come- especially when business is booming-and less in others.

Remember that the aforementioned contribution limits apply per individual person, and not per plan- so in the case that you or your spouse has an outside employment that offers a 401(k), the contribution limits cover both plans.

N/B: You can opt for a solo Roth 401(k) which simulates the tax treatment of a Roth IRA. This option is great if your income and tax rate are lower now as compared to your expectations in retirement.


Suitable for: Self-employed individuals or those owning small businesses with no or few employees.

Contribution limit: The lesser of $58,000 as of 2021 ($57,000 in 2020) or up to 25% of compensation or net self-employment earnings, with a $290,000 ($285,000 in 2020) limit on compensation that can be utilized to factor the contribution. To get the net self-employment income; it is the net profit less half of your paid self-employment taxes and your SEP contribution. There is no catch-up contribution.

 Tax advantage: It is possible for you to deduct the lesser of your contributions or 25% of net self-employment earnings or compensation-restricted to that $290,000 cap per employee as of 2021- on your tax return. In retirement, distributions are taxed as income. There is no Roth version of a SEP IRA.

 Employee element: For each eligible employee (you included), employers are required to contribute an equal percentage of salary. This implies that if you contribute 10% of your compensation for yourself, you are required to contribute the same percentage for each eligible employee’s compensation.

Getting started: With a few extra pieces of paperwork, you can open a SEP IRA at various online brokers similar to how you would a traditional or Roth IRA.

Further details:

It is easier to maintain a SEP IRA as compared to a solo 401(k); this is because of the low administrative burden due to less paperwork and an exemption of submitting annual reports to the IRS. Additionally, this option has similar high contribution limits and it offers flexibility in that you do not have to make yearly contributions.

For this option, the challenge that the employer faces is that s/he has to make equal percentage contributions for employees. This can be quite costly if you have more employees or if your intentions are to save a great amount for your own retirement. This SEP option does not allow you to save for yourself alone, you have to equally contribute a similar percentage for all eligible employee.

4. Simple IRA

Suitable for: Large businesses that have up to 100 employees

Contribution limit: As of 2021, the limit is up to $13,500 plus an additional catch-up contribution of $3,000 for those who are age 50 or older. The total contributions cannot exceed $19,500 if you are also contributing to an employer plan.

Tax advantage: For this option, the contributions are deductible. However, distributions in retirement are taxed. The contributions made to employee accounts can be deducted as a business expense.

Employee element: For a simple IRA, the contribution burden is not exclusively on you; this is because your employees can contribute through salary deferral. However, employers are mostly expected to either make matching contributions of up to 3% of employee compensation to employee accounts or up to 2% fixed contributions to ever eligible employee. The last option does not require the employee to contribute in order to earn your contribution. As of 2021, $290,000 is the compensation limit for factoring contributions.

Getting started: Similar to a SEP IRA, you can open a Simple IRA at an online broker. It is important to note that Simple IRA entails heavier paperwork load than your standard IRA.

 Further details:

If you own a company with less than 100 employees, The Simple IRA is quite a good option because you can easily set it up and the accounts are owned by the employees.

Note that if you have many employees who participate, then this option can be expensive.

Compared to a SEP IRA or Solo 401(k), the contribution limits on a Simple IRA, are considerably lower. The challenge, however, is that there is a possibility that you may end up making mandatory contributions to employee accounts, which may be expensive especially if you have many employees.

Another point of consideration is that the Simple IRA is inflexible; whereby, early withdrawals before age 59½ are treated similar to early 401(k) or IRA distributions; they are taxed as income and one incurs a 10% penalty. In the case that you decide to withdraw within the first two years of participation, this penalty increases from 10% to 25%. This means that it is not possible to roll over a Simple IRA to another retirement account within the two-year period.

N/B: There is a 401(k) version of a Simple, which works in a similar way with an exception that allows participants to take loans from their accounts. For this version, more administrative oversight is required as it can also be quite expensive to set up.

5. Defined benefit plan

 Suitable for: A self-employed individual who has a high income and does not have employees and intends to save a lot for retirement on an ongoing basis.

Contribution limit: The limit is calculated depending on the benefits you will receive at retirement, your age, and the anticipated investment returns.

Tax advantage: The contributions are mainly tax deductible, and distributions in retirement are taxed as income. An actuary has to figure out your deduction limit, which includes an administrative layer.

Employee benefit: In case you have employees, you as the employer generally offer this plan to them and make contributions on their behalf.

Getting started: You have more limited options for brokerage unlike the other plan options discussed above.

 Further details

Most times, we tend to complain about the decline of pension plans; if you are self-employed, it is possible to set up your own pension- an assured stream of income- in retirement by choosing a defined benefit plan.

The question is; why wouldn’t everyone do it? The answer is that these plans are expensive, with high annual and setup fees. If you have employees, these fees increase and you will be obliged to make contributions on their behalf. To add on, these plans have a heavy administrative burden each year and they also require an individual to commit a certain amount per year. If you intend to change that amount, be ready to incur additional charges.

The advantage of this plan is that you can stack lots of money; if you are close to retiring and earning a high income that you are certain that you will maintain and that gives you the opportunity to save a significant amount per year- for instance $50,000 to $80,000 or more- you might consider utilizing this plan to boost your savings efforts.

Where to open a retirement plan if you’re self-employed

Once you have identified the type of account to open, the next step is to decide where to do it.

A majority of online brokers will allow you to open the four most common account types: IRA, Solo 401(k), SEP IRA, and Simple IRA.

Each broker will take you through the whole process of opening one of these accounts by explaining any paperwork that you may need to file with the IRS. However, to be on a safer side, it is important to find an accountant.

What about selling my business?

Many small business owners don’t have retirement savings accounts and they’re counting on the value of their business and what they’re going to get from selling as a part of the retirement savings plan. There’s really nothing wrong with that strategy, however there’s a large percentage of business owners that don’t get a proper business valuation and they guess on what the value of their business is. Often, it’s lower than what business owners expect it to be.

This means your retirement savings from selling your business could be less. So I want to make two points;

  1. Make sure you get your business valued if you plan to sell it and use that money to live on in retirement.
  2. I believe that in order to have the most successful and financially well retirement, it’s important to save.

So, setting up a retirement savings plan is a really good strategy to have the retirement income you will need in retirement once you leave your business.

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