When it comes to advice on saving for retirement, much of the discussion focuses on how to make the most of employer-sponsored tools such as 401(k) plans. While this information is certainly very important for employees with access to these types of savings vehicles, it isn’t much help if you’re among the roughly 16 million Americans who are self-employed.
Fortunately, there are plenty of ways for self-employed individuals to save for retirement that don’t involve relying on an employer. Of course, setting up one or more of these strategies is a do-it-yourself job. You won’t have access to a human-resources team to walk you through the savings-plan application or the opportunity to obtain matching contributions from a company. Instead, you’ll need to rely on the same strategies that you use to run your own business, particularly in terms of planning ahead and staying disciplined, in order to develop your own retirement plan.
The following are some of the most commonly used retirement-savings vehicles for self-employed individuals:
Traditional or Roth IRA
One of the easiest ways for self-employed individuals to start saving for retirement is to open an IRA. These individual plans have no special filing requirements and relatively low contribution limits (up to $6,000 in 2019), which makes them ideal for new entrepreneurs trying to launch a business and those who may not be making significant profits yet. Additionally, if you’re leaving your existing job to become self-employed, you have the option to roll your previous 401(k) into an IRA.
Solo or One-Participant 401(k)
This plan is exclusively for sole proprietors who don’t have any employees, with the exception of a spouse working for the business. Apart from this, solo 401(k) plans are very similar to the 401(k)s that larger companies offer and provide the same tax advantages and contribution limits. If you’re self-employed, one of the main benefits that you’ll gain from starting a solo 401(k) is the ability to contribute to the plan as both the employee and employer. In other words, you can make employee contributions and match them as your own employer, like a company would in a traditional 401(k) scenario. This allows you to claim the tax break for your employee contribution and your employer match. Moreover, solo 401(k)s are simple to set up and administer. For example, if your assets don’t exceed $250,000, there is no requirement to file.
The Simplified Employee Pension (SEP), which is a variant of an individual IRA, is a very easy plan to establish and operate. While it is most beneficial for sole proprietors, it offers the additional advantage of accommodating a few other employees, as well. The most important aspect to understand about SEP IRAs is that you can only contribute to them in your capacity as an employer. Consider this plan as a savings vehicle that you’ve set up on behalf of yourself and anyone else working for you. Furthermore, as the employer, you’re required to make equal contributions for all of your eligible employees. This means that if you want to contribute 10% of your compensation for yourself, for example, you must contribute the same amount for anyone else working for your company: You don’t have the option to give yourself more. While this may not make a significant difference if you have only one or two employees, this type of plan can become costly if you have a larger workforce.
A hybrid of an IRA and a 401(k) plan, the Savings Incentive Match Plan for Employees (SIMPLE) is a good option if you run your own business with less than 100 employees. The plan is also available for sole proprietors. Unlike a SEP IRA, a SIMPLE IRA is based on the premise that employees make their own contributions, so the responsibility of contributing isn’t entirely on the employer. However, employers are usually required to make matching contributions of up to 3 percent of employee compensation or fixed contributions of 2 percent to every eligible employee. It’s also important to be aware that SIMPLE IRAs come with an early withdrawal penalty of 10 percent if taken out before age 59-and-a-half. This increases to 25 percent within the plan’s first two years.
Also known as the HR 10 plan, but more commonly referred to as a qualified or profit-sharing plan, the Keogh plan is perhaps the most complex option for self-employed individuals. However, it also allows for the greatest potential for retirement savings. HR 10 plans are typically structured as defined contribution plans, which involve contributing a fixed percentage or sum during every period, although they can also be established as defined benefit plans. They can prove somewhat complicated to set up (professional help is usually required), so they are usually most appropriate for self-employed individuals who have high incomes or who want to be able to save a lot for retirement quickly.