Understanding self-employed retirement plans

Just because you work for yourself doesn’t mean you have to miss out on the kind of retirement plans that you might find in a traditional workplace. Self-employed individuals and small business owners enjoy several options for self-employed retirement plans, ranging from individual retirement accounts (IRAs) to 401(k) plans.

Follow along to learn more about self-employed retirement plans.

Key takeaways

  • There are a variety of retirement plans for those who are self-employed.
  • Every self-employed retirement plan has its own pros and cons.
  • Before choosing a retirement plan, self-employed individuals should compare things like the contribution limits and tax implications of each option. 

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What are retirement plans for self-employed workers?

Retirement plans for self-employed workers allow money to be put aside for retirement—much the same way that employees in traditional workplaces are able to do.

The options include the following:

  • Traditional IRA, whose pretax contributions may be tax-deductible and whose withdrawals generally are taxed 
  • Roth IRA, whose after-tax contributions are not tax-deductible and whose withdrawals are tax-free
  • Solo 401(k), which is available only if someone is self-employed but has no employees
  • Simplified Employee Pension (SEP) IRA, which enables employers of any size to set aside retirement savings for themselves and their employees
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA, which lets employers and employees of small businesses make tax-deferred retirement contributions
  • Profit-sharing plan, which allows a self-employed person to put a share of their net earnings toward retirement
  • Money purchase plan, which is a retirement plan that’s similar to a profit-sharing program

Why invest in a self-employed retirement plan?

Self-employed individuals and small business owners could consider investing in a self-employed retirement plan to help them retire comfortably and not prolong their time in the workforce.

While 68% of self-employed workers indicated in a 2021 survey by the Transamerica Center for Retirement Studies that they were saving for retirement, 34% saved only from time to time. And 20% never saved for retirement at all. Furthermore, few self-employed workers reported taking advantage of retirement plans designed for sole proprietors or small businesses, such as the solo 401(k) and SEP IRA—both of which offer generous contribution limits.

Traditional and Roth IRAs

An IRA is a savings account that lets people save for retirement and offers tax benefits.

Generally, anyone with earned income can set up an IRA at a financial institution, such as a bank, credit union or investment brokerage. The IRS limits contributions to IRAs based on someone’s age and income, along with the type of IRA.

A self-employed person can open a traditional IRA or Roth IRA:

  • A traditional IRA lets someone contribute money that has not been taxed. The money grows on a tax-deferred basis until the account holder takes out money for retirement. At that point, withdrawals are taxed. Contributions may qualify for tax deductions.
  • A Roth IRA lets someone contribute money that already has been taxed. Money in the account grows on a tax-free basis. Contributions are not tax-deductible. Someone who is at least 59½ years old and has had their Roth IRA for at least five years can withdraw money without being taxed or penalized.

For 2023, the IRS generally caps all annual contributions to traditional and Roth IRAs at $6,500 for someone up to age 50 or $7,500 for someone 50 or older.

IRA pros 

Some of the pros of an IRA include the following:

  • Traditional and Roth IRAs provide tax advantages.
  • IRAs are easy to set up.
  • In 2023, the IRS allows someone at least 50 years old to make catch-up contributions totaling $1,000 to their traditional and Roth IRAs—for a total of $7,500 in annual contributions.

IRA cons 

Some of the cons of an IRA include the following:

  • Annual contributions are capped. In 2023, contributions are capped at $6,500 or $7,500, depending on age.
  • Roth IRAs come with contribution limits based on income.
  • Taxes and penalties may be owed for early withdrawals.

Solo 401(k)

A solo 401(k)—also known as an individual 401(k)—lets a self-employed person make contributions as both employer and employee. To participate in a solo 401(k), a self-employed person must not have any employees.

A traditional solo 401(k) features pretax contributions and taxable withdrawals, while a Roth solo 401(k) features after-tax contributions and mostly tax-free withdrawals.

Excluding catch-up contributions, a self-employed person can put as much as $66,000 into a solo 401(k) in 2023. The limit for someone 50 or older is $73,500.

Solo 401(k) pros 

Some of the pros of a solo 401(k) include the following:

  • A self-employed person can contribute as both employer and employee.
  • A solo 401(k) offers tax benefits.
  • A solo 401(k) can be a traditional or Roth plan.

Solo 401(k) cons 

Some of the cons of a solo 401(k) include the following:

  • Opening and maintaining a solo 401(k) may be more difficult than some other retirement plans.
  • Some solo 401(k) plans don’t allow loans.
  • Early withdrawals face taxes and penalties.

SEP IRA

A SEP IRA enables a self-employed person, business owner, employer or freelancer to set aside money for retirement. In 2023, the IRS permits contributions of up to 25% of a worker’s pay or $66,000, whichever is lower.

SEP IRA pros 

Some of the pros of a SEP IRA include the following:

  • A SEP IRA is easy to set up and maintain.
  • Contribution limits exceed those of non-SEP traditional and Roth IRAs.
  • Contributions are made with pretax dollars, meaning qualified withdrawals are tax-free.

SEP IRA cons 

Some of the cons of a SEP IRA include the following:

  • Employees cannot make their own contributions.
  • Catch-up contributions are not allowed.
  • Withdrawals before age 59½ are subject to tax penalties.

SIMPLE IRA

A SIMPLE IRA lets employers and employees contribute to traditional IRAs created for employees. A SIMPLE IRA is generally available to any small business with 100 or fewer employees. Contributions are done on a pretax basis and are subject to taxes when retirement withdrawals are made.

In 2023, an employee’s contributions to a SIMPLE IRA are capped at $15,500, but catch-up contributions may be allowed. An employer’s matching contributions range from 1% to 3% of an employee’s compensation.

SIMPLE IRA pros 

Some of the pros of a SIMPLE IRA include the following:

  • SIMPLE IRAs are easy to set up and operate.
  • Employer and employee contributions are permitted.
  • Contribution limits are higher than they are for traditional IRAs.

SIMPLE IRA cons 

Some of the cons of a SIMPLE IRA include the following:

  • Contribution limits are lower than they are for some other retirement plans.
  • An account holder cannot borrow money from a SIMPLE IRA.
  • Withdrawals before age 59½ or early in the life of the plan face tax penalties.

Profit-sharing plans

A profit-sharing plan lets an employer share some of its profits with its employees. An employer gives employees a percentage of profits based on how much the employer’s quarterly or annual earnings are. A business of any size can set up a profit-sharing plan, even if it already offers other retirement options.

In 2023, the contribution limit is either 100% of an employee’s compensation or $66,000, whichever is less. An employer can share profits up to 25% of the employer’s payroll. The employer determines how much they’ll pitch in.

Profit-sharing plan pros 

Some of the pros of a profit-sharing plan include the following:

  • Any company can set up a profit-sharing plan.
  • A profit-sharing plan can complement an employer’s other retirement options.
  • Catch-up contributions are allowed for employees 50 and older.

Profit-sharing plan cons

Some of the cons of a profit-sharing plan include the following:

  • Operating costs may be higher than they are for other retirement plans, such as SIMPLE and SEP IRAs.
  • Withdrawals before age 59½ may be hit with tax penalties.

Money purchase plans

A money purchase plan is similar to a profit-sharing plan. The biggest difference: Unlike a profit-sharing plan, contributions to a money purchase plan are made according to a fixed percentage of a worker’s annual compensation.

In 2023, an employer can contribute up to 25% of the total annual compensation for every employee participating in the plan and up to 100% of each participant’s salary or $66,000, whichever is less.

Money purchase plan pros 

Some of the pros of a money purchase plan include the following:

  • A business of any size can create a money purchase plan.
  • A money purchase plan can be coupled with other retirement plans.

Money purchase plan cons

Some of the cons of a money purchase plan include the following:

  • An employer must contribute to the plan, even if the employer hasn’t turned a profit.
  • The IRS taxes an employer when it fails to meet the minimum contribution amount.
  • The costs of maintaining a money purchase plan may be higher than for other retirement plans.

What to consider when choosing a self-employed retirement plan

Here are some questions to consider when choosing a self-employed retirement plan:

  • What are the eligibility requirements? For instance, is the plan available only to self-employed people?
  • What are the tax benefits?
  • Who can contribute to the plan—employers, employees or both?
  • Can spouses make contributions?
  • What are the contribution limits?
  • How much flexibility is there regarding contributions?
  • Are catch-up contributions allowed?
  • What are the rules surrounding withdrawals and loans?
  • What are the requirements for maintaining the plan?

Self-employed retirement options in a nutshell

Fortunately, self-employed people have several options for establishing a retirement plan.

Every retirement plan available to self-employed Americans comes with its own advantages and disadvantages. So before setting up a plan, a self-employed individual or employer should compare options and nail down various details—such as who is eligible to participate and what the tax implications are. If you have questions about your particular situation, consider seeking advice from a professional.

Ultimately, a plan should help employers and employees save enough money to retire comfortably.

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