The Ultimate Guide to Self-Employed Retirement Plans

by | Aug 15, 2023

Most people already know how crucial it is to prepare for retirement as early as possible. Unlike full-time employees who may have access to 401(k) plans and other company-supported retirement plans, self-employed individuals must take the initiative to set up their own plan. With so many options available, which one is right for you?

If you want to learn more to determine which self-employed retirement plan will help you reach your goals, here is the breakdown you need.

Solo 401(k)

For those who have been employees in the past, you may already be familiar with a 401(k), and this Solo(k) option is an easy transition. It is designed for self-employed business owners who generally don’t have employees and comes without age or income restrictions.

The Solo(k) offers a high contribution limit for those who have put off retirement planning until the last minute. In 2023, you can contribute up to $66,000 with catch-up contributions of $7,500 for individuals aged 50 or older.

Pros:

  • High contribution limits
  • Can add spouses, partners, and partners’ spouses to the plan if they work in the business
  • Contributions are tax-deductible

Cons:

  • May not have any employees (other than a spouse)
  • Could require a 5500 Form filed at the end of each year
  • Has more IRS and DOL regulations that can be complicated
  • Usually requires a small annual expense to operate

This plan is best for business owners who are running a solo enterprise and want to make some serious contributions to their retirement accounts.

SEP IRA

A Simplified Employee Pension Individual Retirement Account (SEP IRA) is another excellent option for business owners who have few employees on their payroll. It’s extremely similar to traditional IRAs where your contributions are tax-deductible and are only taxed as income upon withdrawal in retirement.

If you have employees, you can still use SEP IRAs as your preferred retirement plan. You can make contributions at whatever percentage you want on behalf of the business, but generally, you must set an equal contribution for each employee. If you match up to 3% for yourself as the business owner, you will also need to match 3% for your workers.

Like the Solo(k), you will find a higher contribution limit of $66,000 in 2023 but with no catch-up options.

Pros:

  • High contribution limits
  • Tax-deductible contributions
  • No annual requirements for contributions

Cons:

  • No catch-up contributions for older individuals
  • Equal contributions for all employees required
  • Must make distributions by age 72
  • Early withdrawals subject to a 10% penalty

This plan is best for business owners who want to make contributions on behalf of their business and want their retirement savings to be taxed as income upon withdrawal in retirement.

SEP IRA vs. Solo(k) Plans

When considering self-employed retirement plans, one crucial point to note is that while the SEP IRA and Solo(k) have the same maximum contributions, you can actually contribute a higher amount under a Solo(k).

For example, a business owner under a sole proprietor making $100,000/year could contribute a maximum of $20,000 under a SEP IRA program. A Solo(k) plan would allow that sole proprietor to essentially contribute twice, since they are both employer and employee. They can invest the employer contribution of $20,000 along with the employee contribution of $22,500, resulting in a grand total of $42,500.

If the individual is 50 or older, they can contribute an additional $7,500, making the full contribution amount to $50,000 — a whopping $30,000 higher than what they would be allowed with a SEP IRA.

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is perfect for small businesses that want to get started quickly and easily with a traditional IRA for their employees. Ideally, this plan is used for companies with fewer than 100 employees and is only applicable if there are no other retirement plans.

Unlike Solo(k)’s and SEP IRAs, the contribution limits are lower for SIMPLE IRAs at $14,000 for 2022 and a catch-up contribution of an additional $3,000 for those older than 50.

Pros:

  • Very few paperwork requirements outside of account setup
  • Must have fewer than 100 employees

Cons:

  • Employers are required to contribute annually until the plan is terminated
  • Lower contributions permitted
  • Two-year waiting period to rollover to a traditional IRA

This plan is best for small businesses that have a few employees and want to manage a retirement account with minimal effort.

Defined Benefit Plan

A defined benefit plan is frequently used in conjunction with other retirement savings programs, though not always. In this type of plan, employees who participate are given a fixed benefit upon their retirement. You might be more familiar with this under another name, as these are often referred to as pension plans.

Businesses that opt for this type of plan must complete a lot more paperwork to manage it and frequently require outside help to do so. Pensions or defined benefits are determined based on length of employment, salary history, and other factors. Benefits can be distributed as monthly payments (similar to an annuity) or as a lump sum.

Pros:

  • Easy to predict benefits at retirement
  • More contributions and deductions for the business compared to other plans
  • May offer subsidized early retirement plans
  • Benefits can be accrued with short time investments

Cons:

  • Most expensive of all retirement plans for small businesses
  • Requires more paperwork and administrative work for self-employed businesses
  • Investments are usually set with a low return on investment.
  • The employer can be required to contribute if the investments don’t earn the set interest rate.

This plan is best for those who are older (over age 50) and can make substantial contributions each year for the next five to ten years. It is best if you have very few employees or no employees at all outside of yourself.

Traditional or Roth IRA

Many people have heard of traditional or Roth IRAs before and feel more comfortable with these types of investments as a result. It’s essential to understand the differences between these two types of accounts first, though.

In a traditional IRA, your savings grows tax-deferred and any withdrawal made in retirement is taxed as current income. This is better if you think that you will be in a lower income tax bracket upon retiring.

On the other hand, Roth IRAs allow you to contribute after-tax dollars that will grow tax-free with no taxes paid on withdrawals taken after the age of 59 ½. If you think that you will be in a higher income tax bracket upon retirement, a Roth IRA is the way to go.

Pros:

  • Lots of options for contributing either pre- or after-tax dollars
  • Not required to take distributions during your lifetime

Cons:

  • Low maximum contributions permitted — Only $6,000 per year, or $7,000 if you’re aged 50 or older
  • Can’t withdraw earnings before age 59 1/2
  • Income limit of $144,000 for single filers or $214,000 for married filing jointly

This plan is for any individual who wants something simple to understand, an easy way to diversify their investment portfolio, and who may want to use their retirement account as a way to pass on wealth after their passing.

Let the Experts Help

Setting up self-employed retirement plans can be complicated, especially when you already have your hands full running your own business. Retire4one makes it easy to set up a Solo(k) so you can start reaping the benefits of retirement planning. Manage your Solo(k) using your own research and the tools provided by Retire4one and Voya — it’s that easy. Get in touch today to learn more.