Self-Employed Plans

Self Employed Plans – Retirement for the Self-Employed

If you’re an employee of a company or organization, you may be a participant in a retirement savings plan, such as a 401(k) or 403(b). Oftentimes, these employer-sponsored plans are already set up, and all you have to do is start contributing to it.

There may be additional perks for you in a company-sponsored retirement savings plan, too, such as matching contributions from your employer and profit-sharing deposits. But what if you are self-employed? Can you still build up savings for the future via your business?

Self-Employed Retirement Savings Options

The good news is that there are a variety of plans available to self-employed individuals for retirement savings. These can include the following:

SEP IRA Account

SEP IRAs, or Simplified Employee Pension Individual Retirement Accounts, can provide self-employed individuals a way to grow funds on a tax-advantaged basis for the future. These plans are relatively easy to establish and may be opened through a bank, brokerage, or other financial institution. 

With a SEP-IRA plan, you may contribute much more than you can with an individual IRA account. For instance, if you are self-employed, you may put in up to 25% of your net earnings from self-employment (not including contributions for yourself), up to $57,000 for the 2020 tax year, or $58,000 for 2021. 

Contributions to a SEP plan go in pre-tax, and the funds in the account are allowed to grow on a tax-deferred basis. This means that there is no tax due on the growth until the time of withdrawal. At age 72, you are required to start taking distributions from a SEP plan. Because none of the money in a SEP IRA has been subject to income taxation yet, the withdrawals will typically be 100% taxable at your then-current income tax rate.

SIMPLE IRA

Another retirement plan for self-employed individuals is the SIMPLE IRA. The acronym SIMPLE stands for Savings Incentive Match Plan for Employees. You are allowed to contribute all of your self-employment earnings into a SIMPLE IRA plan, up to a maximum of $13,500 (in 2020) if you are age 49 or younger, or $16,500 if you are age 50 or older. 

In addition, your company can add either an additional 2% fixed contribution or a 3% matching contribution to the account. The earnings in a SIMPLE IRA are also tax-deferred until withdrawal, and these plans are subject to the IRS required minimum distribution rules. 

Solo 401(k) Plan

As a self-employed individual, you may be able to open a Solo 401(k) plan. These plans are specifically for those business owners who have no employees (other than their spouses). A Solo 401(k) works in a similar fashion to an employer-sponsored 401(k) in that you can make pre-tax contributions to a traditional plan, and the earnings are allowed to grow tax-deferred. Withdrawals from a traditional Solo 401(k) are 100% taxable as income. 

With a Roth Solo 401(k), contributions are made with after-tax funds, and the withdrawals come out tax-free, regardless of your future income tax rates. This can allow you a more considerable amount of net retirement income for your spending needs.

As a sole proprietor or single-member LLC, you can contribute 25% of your net self-employment income. This equates to your company’s net profit, minus half of your self-employment tax, and also minus any of the contributions you made for yourself into the plan. 

Contributions may be made up to $57,000 (in 2020) if you are age 49 or younger, plus an additional $6,000 if you are age 50 or over. The traditional Solo 401(k) plan is subject to the IRS required minimum distribution rules. However, the Roth Solo 401(k) plan is not. 

How to Add to Your Savings with a Personal IRA Account

In addition to your business-related retirement plan, you could also be able to take advantage of a personal IRA (Individual Retirement Account). IRAs can be traditional or Roth. You may be eligible to have both an individual and a Roth IRA account. 

Traditional IRA Account

Contributions to a traditional IRA are typically pre-tax. This can reduce the amount of taxable income you had for years when you made a contribution. Earnings grow tax-deferred. Therefore, in most cases, 100% of the traditional IRA distributions will be fully taxable. 

Like a traditional SEP and SIMPLE plan, traditional IRA accounts are subject to the IRS’s required minimum distribution rules. This means that you must begin taking at least a certain amount out after you have reached age 72. (Otherwise, you could face a penalty of 50% of the shortfall amount). 

Annual maximum contributions to a traditional IRA are $6,000 if you are age 49 and younger and $7,000 (in 2020) if you are age 50 or older. These amounts are the same for 2021 IRA contributions. 

Roth IRA Account

Roth IRAs offer individuals some nice tax incentives. For instance, while you cannot deduct the amount of the contribution on your income tax return, the earnings in a Roth IRA are tax-free, as are the withdrawals. 

The same annual maximum contribution limits apply to the Roth IRA. If an investor has a traditional and a Roth IRA account, the contribution limit is cumulative, meaning that deposits may be made to both accounts. Still, the total dollar amount may not exceed the annual total limit. 

Also, there are income limits in place for Roth IRA accounts. So, investors who earn “too much” may not be eligible to open a Roth IRA. If you fall into this category, though, there may still be some viable strategies for participating in this retirement account type. 

Which Retirement Plan is Right for You?

If you are self-employed, you may have several options available to save for the future while at the same time taking advantage of tax-related incentives. Before opening or funding a retirement account, it is recommended that you first discuss your objectives and your options with a retirement income planning professional.