Nearly a quarter of the American workforce engages in some form of self-employment, whether as consultants, gig economy workers, or small business owners. While self-employed individuals often struggle to obtain affordable health care coverage and other benefits traditionally provided by employers, they're spoiled for choice when it comes to retirement planning.
The most attractive tax-advantaged retirement plans for self-employed workers are the Solo 401(k) (also called Individual 401(k)); the Traditional and Roth Individual Retirement Accounts (IRAs); the SIMPLE IRA; and the Simplified Employee Pension (SEP) IRA. With the exception of the Roth options, each of these plans allows you to contribute pretax funds to a retirement account, choose from a wide array of investments, and withdraw your contributions and earnings at retirement, to be taxed as ordinary income.
Read more about the specifics of each plan—including eligibility requirements and contribution limits—to find the one that's right for you. For further details, contact a financial planner, wealth manager, or the IRS.
Solo/Individual 401(k) Plans
- Who's eligible. Self-employed individuals with no employees (other than a spouse). Traditional employees with sides businesses also qualify—for example, a barista with an Etsy shop.
- How it works. You make contributions to your Solo 401(k) on a pre-tax basis and pay tax on withdrawals, which can start at age 59½. (Penalties apply for early withdrawals.) Many providers also offer a Roth option, which allows for taxable contributions and tax-free disbursements. If the plan's total assets exceed $250,000, you must make an annual filing with the IRS.
- Contribution limits. Up to $56,000 in 2019, not counting any catch-up contributions. As a self-employed individual, you can contribute to a Solo 401(k) as both employer and employee. The maximum employer contribution is calculated according to an IRS formula, but roughly equates to 25 percent of your net self-employment income—and can't exceed $37,000. The employee portion of your contributions (known as an "elective deferral") is capped at $19,000 in 2019, with an additional $6,000 of catch-up contributions available to those aged 50 and older.
Traditional IRAs and Roth IRAs
- Who's eligible. Most self-employed workers and traditional employees, although in order to be eligible for a Roth IRA, your modified adjusted gross income must fall below the threshold set annually by the IRS.
- How it works. Though not specifically designed for the self-employed, traditional and Roth IRAs are nevertheless great options for them. With a traditional IRA, contributions are tax-deductible and taxes are paid on the withdrawals. Roth IRAs have the reverse structure: contributions are after-tax but withdrawals are tax-free. You must wait until age 59½ to begin withdrawing from a traditional IRA, or you’ll be hit with a 10% penalty. The Roth IRA offers greater flexibility, as you can withdraw your contributions (but not earnings) penalty-free at any time. You can access the earnings at age 59½.
- Contribution limits. $6,000 in 2019, plus an additional $1,000 in catch-up contributions for over-50s.
- Who's eligible. Self-employed individuals and business owners with up to 100 employees.
- How it works. Contributions to a SIMPLE IRA are made on a pre-tax basis; withdrawals are taxable. For business owners with employees, the IRS requires that the employer match an employee's contributions of up to three percent of their compensation, or contribute a fixed amount of two percent. Starting and maintaining a SIMPLE IRA plan tends to be cheap and straightforward.
- Contribution limits. $13,000 in 2019, plus an additional $3,000 in catch-up contributions if you're older than 50.
- Who's eligible. Self-employed workers and business owners with at least one employee.
- How it works. As with most of the other plans, contributions are made on a pre-tax basis and distributions are taxable. Penalty-free withdrawals can begin at age 59½. Note that SEP IRAs don’t allow catch-up contributions or offer a Roth option. individuals can't borrow from their SEP IRA, although SEP IRAs can be converted to Solo 401(k)s, which do permit loans, if desired. On the positive side, it is somewhat easier to administer a SEP IRA than a Solo 401(k).
- Contribution limits. Maximum contributions are calculated according to a formula totaling roughly 25 percent of net self-employment income up to $56,000 (in 2019).
For more information about each option, check out IRS Publication 560, Retirement Plans for Small Business.
How to Open a Retirement Account
Just about any online or brick-and-mortar broker will offer the above retirement plans to self-employed individuals. Before choosing a broker, do your research so that you're comfortable with the associated fees and the level of customer service provided. As you might expect, online brokers tend to have much lower fees, but usually can’t match the level of service provided by a traditional broker.