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Retirement Savings for the Self-Employed

retirement savings for the self-employed

Most adults are familiar with a 401(k) and how important it is to save for retirement, but what about those individuals who are not employed by a company or organization? How does retirement savings for the self-employed work? How they can save for retirement and receive the benefits of tax-deferred saving? Unlike an employee who probably has access to a company-sponsored 401(k), the options are different when you work for yourself.

Retirement Savings for Self-Employed or Contractors

The first step in any retirement savings plan is to determine how much you need to save to meet your retirement goals. It’s important to have a plan so you know what you’re working for.

Once you have a goal, the next step in a retirement plan is to decide where you’re going to save that money. There are several options available if you don’t qualify for a company-sponsored retirement account. Let’s look at the primary options.

Individual or Solo 401(k)

The Individual or solo 401(k) is also referred to as a one-participant 401(k). A 401(k) designed as an option for retirement savings for the self-employed. This type of account has many of the features of an employer-sponsored plan. You cannot contribute to a solo 401(k) if you have full-time employees on your payroll, but you can cover both yourself and a spouse.

The individual 401(k) has tax benefits much the same as an employee-sponsored 401(k): Contributions are made pre-tax, and distributions after age 59½ are taxed.

As with other retirement accounts, there are contribution limits of up to a maximum of $57,000 in 2020 (plus a $6,000 catch-up contribution for those 50 or older.) Under the plan, you can make contributions as an employee and employer allowing for optimal savings. For example, as an employee, you can only save the maximum ($19,500 in 2020), but also as an employer you can save up to an additional 25% as the employer. This is great news for the super saver.

SEP IRA

A SEP IRA is a retirement savings plan for sole proprietors and small business owners with employees. The SEP IRA allows these individuals to save for retirement on a tax-deferred basis up tp $57,000 in 2020 ($56,000 in 2019) or up to 25% of compensation or net self-employment earnings, with a $285,000 limit.

The SEP IRA is different from the solo 401(k) in that you can utilize it if you have employees on your payroll. The catch is that as the employer, you must make contributions for eligible employees of an equal percentage of pay as you make for yourself. You cannot use a SEP to save for yourself only.

With a SEP IRA, contributions are made with pre-tax dollars and are tax deductible up to 100% of what you contribute or 25% of net self-employment earnings limited to that $285,000 for each employee. The SEP IRA has lower administrative costs associated with these accounts and are less time-consuming.

Defined Benefit Plan

The Defined Benefit Plan can also be known as pension plan or a qualified-benefit plan. It is for self-employed individuals who have a high income and wants to save the maximum for retirement. It allows for the highest contribution amounts among all options, (although it also has the hefty administrative fees.)

The Defined Benefit Plan requires a commitment to fund the plan with a certain amount each year and fees if you change the amount, but for those who require the ability to save a significant amount each year, it may be worth it.

Simple IRA

Lastly, the Simple IRA is an option. It is suited as retirement savings for self-employed or small employers not sponsoring a retirement plan.

A Simple IRA plan follows the same rules as a traditional IRA with low administrative fees, but lower contribution limits than other plans.

Those who contribute to a Simple IRA may contribute 100% of their income up to the maximum amount of $13,500 in 2020 or $13,000 for 2019 (plus a catch-up contribution of $3,000 if 50 or older.)

Most online brokers will allow you to open these common retirement savings accounts and help you understand what paperwork you may need to file with the IRS for your account. If you’re looking for information about specific providers, check out a list of  IRA providers to get started.

CESI does not provide specific investment advice. It’s important to consult an accountant and/or a financial advisor for the best information suited to your specific situation.

If you are looking to understand retirement savings for the self-employed or contractors, make sure you consider all of your available options and maximize your retirement savings as soon as possible for a healthy financial future.

Consumer Education Services, Inc. (CESI) is a non-profit committed to empowering and inspiring consumers nationwide to make wise financial decisions and live debt free. Speak with a certified counselor for a free debt analysis today.


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1 Response to Retirement Savings for the Self-Employed

  1. Tara says:

    Very clear and helpful. Thank you so much

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