Retirement Plan Options for the Self-Employed
Self-employed professionals have plenty of retirement savings options. But you'll need to be proactive about researching and setting up a retirement plan.
Published December 4th, 2020
Table of Contents
- There are five major types of retirement plans for sole proprietors: IRAs, 401(k)s, SEPs, SIMPLE IRAs, and defined benefit plans.
- Each type of plan is defined by its annual contribution limits, which are set by the IRS.
- By contributing to a retirement plan, you can reduce your tax burden each year while also preparing for the future.
Retirement saving has become complicated in the self-employment era. Working independently is on the rise, with 28 percent of workers going full-time freelance in 2019, compared to only 17 percent in 2014. In fact, about 35 percent of the U.S. workforce did freelance work in some capacity in 2019, and many self-employed professionals have no plans to shift to salaried work in the future.
This drive toward independent contracting has created a problem, though. Without employer-provided retirement savings options, some freelancers are failing to set money aside for their golden years. Two-thirds of millennials lack any retirement savings, and 40 percent cite a lack of retirement savings options through work as a reason.
But you don’t need to have an employer to set up a retirement savings account. There are plenty of retirement plan options for self-employed workers.
Traditional and Roth IRAs for freelancers
If you’re just getting started, an individual retirement account (IRA) is probably one of the best self-employed retirement plans you can find. They’re especially beneficial to those leaving the workforce to freelance, since you can roll over an employer-provided 401(k) into an IRA.
For the self-employed, IRAs are typically offered in two major types: traditional and Roth. With a traditional IRA, you can deduct your contributions on your taxes, which makes it a great option for socking some of your earnings away that you would otherwise give to the IRS. However, you’re only deferring taxes until retirement. With a Roth IRA, you can’t deduct the money you put in, but the benefit is that you can enjoy tax-free withdrawals when you retire.
With a traditional or Roth IRA, self-employed professionals need to pay attention to the contribution limits. For 2021, you’re limited to $6,000 for the entire year unless you’ll be age 50 or older by December 31, at which point the limit increases by $1,000. If your annual compensation was less than that, you’ll be limited to the amount you made that year. In addition to annual contribution limits, the IRS sets certain limits on who can contribute to IRAs based on their adjusted gross income.
Solo 401(k)s for freelancers
You may not be eligible for large or small business retirement plans, but you still can participate in a solo 401(k). In this setup, the self-employed person acts as both the employer and employee, which means contribution limits are higher. You can contribute up to $19,500 in 2021. If you’re age 50 or older, you can set aside an additional $6,500 for a total of $26,000. Additionally, you can contribute up to 25 percent of your earnings. In total, your contributions in 2021 can’t exceed $58,000, including salary deferrals (or $64,500 including catch-up contributions).
SIMPLE IRAs for freelancers
Another retirement plan option for self-employed professionals is a SIMPLE IRA, which is short for Savings Incentive Match Plan for Employees. The limit for a SIMPLE IRA is $13,500 in 2021, or $16,500 for those aged 50 or older. You can also contribute an additional 2% fixed amount or a 3% matching contribution. Self-employed individuals that have employees are also required to make employer contributions under SIMPLE IRA rules.
SEP IRAs for freelancers
Another type of IRA worth considering is a Simplified Employee Pension (SEP). The biggest difference in a Solo 401(k) vs. SEP IRAs is how contribution limits are calculated. With a SEP IRA, you can set aside 25 percent of your net self-employment earnings $58,000 for 2021. SEP IRAs do not allow for catch-up contributions for self-employed individuals age 50 or over.
Defined Benefit Plans for freelancers
By definition, it may seem like defined benefit plans aren’t a viable retirement plan option for freelancers. A defined benefit plan is an employer-sponsored plan like a pension, provided as a perk of employment. Pensions are typically funded based on an employee’s salary and years of service.
But defined benefit plans are still available as retirement accounts for self-employed professionals. These are called personal defined benefit plans and often appeal to freelancers who are making too much money to take advantage of the qualified business income (QBI) deduction. QBI was passed under the Tax Cuts and Jobs Act, allowing business owners and sole proprietors to deduct 20 percent of your business’s income. But if your household income is more than $315,000, you can’t participate in QBI.
If you’re in a high-earning household, a defined benefit plan could be a great way to save for retirement while also reducing your tax burden each year. The limit is calculated based on your age, expected return, and the amount you’ll receive at the time you retire. Usually you’ll be able to set aside tens of thousands of dollars before reaching the cap.
Starting a retirement benefit plan
When you accept a salaried position, signing up for a retirement plan is often included as part of the onboarding process. You don’t have that convenience when you’re self-employed, which means you’ll have to seek out a plan on your own. The good news is, there are plenty of financial institutions and brokers willing to help you out. You may even be able to set it all up online.
In addition to researching the best retirement plan for self-employed workers, you should also shop around to find the lowest fees. Conduct a web search for the best providers of the type of account you want to open, and compare rates, application processes, investment options available, and reporting tools. You’ll then have the basic information you need, whether you choose to speak to an expert or sign up on your own.
Whether you choose a self-employed SEP, SIMPLE IRA, IRA, 401(k), or defined benefit plan, it’s important to get advice from a licensed professional – a Certified Financial Planner® can help you sift through the weeds and find the best plan for you.