4 Retirement Plan Options for Self-Employed People

When you work for a company, saving for retirement often can be straightforward. Provided you can participate in a plan, you may be able to put a percentage of your paycheck into your retirement account automatically. Your employer might even match your contribution.

But when you're your own boss, saving for retirement can be more complicated. Fortunately, there are several retirement plan options for self-employed people. Here are four strategies to consider when deciding how to set up a self-employed retirement plan.

1. SEP IRAs

Simplified employee pension (SEP) individual retirement accounts (IRAs) allow employers to contribute the lesser of $69,000 or 25% of each employee's salary (or their own pay, if they're a small business owner) to a dedicated retirement account.¹ Anyone who generates self-employment income is eligible for a SEP IRA, whether they're a solo entrepreneur, a small business owner with just a few employees or someone working freelance jobs on the side.

Compared with traditional employer-based retirement plans, SEP IRAs can be easier to set up and have fewer administrative costs. Additionally, they give small business owners the flexibility to contribute different amounts each year for themselves and their employees depending on the business's cash flow. It's important to note that employees themselves aren't allowed to contribute to SEP IRAs even though they own them.

For freelancers and small business owners, the main advantage of a SEP IRA is that it allows them to contribute more for retirement each year. For those younger than 50, traditional and Roth IRAs have a $7,000 annual contribution limit (those age 50 and older have a contribution limit of $8,000).² SEP IRAs can allow self-employed workers to contribute much more money to their accounts each year, potentially helping them build their retirement savings faster.

Another advantage of SEP IRAs is that contributions are tax-deductible. This means you can both reduce your current tax bill and save for retirement. However, you need to be careful not to withdraw money from a SEP account too early. If you do so before age 59½, you'll be subject to an additional 10% tax.³ It's also important to follow the annual contribution limit guidelines. If you contribute too much, you may have to pay a 6% penalty on the excess contribution unless you withdraw the excess before that year's tax filing deadline.⁴

2. SIMPLE IRAs

Any small business owner with 100 or fewer employees can open a savings incentive match plan for employees (SIMPLE) IRA for both themselves and their business's employees. While it's similar to a SEP IRA, the two plans differ in some important ways.

With a SIMPLE IRA, small business owners are required to contribute each year.⁵ They can either make a matching contribution of up to 3% of each employee's salary or a 2% non-elective contribution equal to 2% of each employee's eligible annual compensation (up to $345,000 for 2024). This is required regardless of whether that employee contributes to the retirement plan. But unlike SEP IRAs, employees are allowed to contribute directly to their SIMPLE IRAs.

If you're a small business owner, you can deduct any contributions you make to a SIMPLE IRA for your employees on your business's tax return.⁶ And if you're a sole proprietor or a partner, you can deduct contributions to your own SIMPLE IRA retirement plan — and any matching and nonelective contributions you've made for employees — on your personal tax return.

One downside to a SIMPLE IRA is that as an employer, you can't have any other retirement plans in most cases. They also restrict withdrawing money before age 59½. If you do, you may pay a 10% penalty along with income taxes unless you qualify for an exception, such as having a disability, qualified education expenses or unreimbursed medical expenses that exceed 10% of your adjusted gross income. There's also a 25% tax penalty if you make an early withdrawal within two years of initially participating in a SIMPLE IRA plan.⁷

Like a SEP IRA, the main benefit of a SIMPLE IRA is that it allows you to save for retirement as a freelancer or small business owner while still getting a tax deduction. This may free up money that you could reinvest in the business or put toward your retirement savings if you haven't already exceeded your contribution limit for the year.

3. Solo 401(k)s

A solo or one-participant 401(k) plan is designed for freelancers and small business owners who have no other employees.⁸ A solo 401(k) covers you as a business owner as well as your spouse if they earn income from the business. Under this retirement plan, you act as both the employee and the employer and can make contributions as both. You can make elective deferrals of up to 100% of your earned income — up to $23,000 if you're younger than 50 or $30,500 if you're 50 or older.

You also can make employer nonelective contributions of up to 25% of compensation. The total amount you contribute cannot exceed $69,000, and contributions can be made before or after paying income tax. There's also a 10% early withdrawal penalty on these accounts.⁹

As a self-employed person, you'll likely need to do some math to determine your earned income, which is defined as your net earnings after deducting half your self-employment tax and any contributions you make for yourself.⁸ Once you've figured out this number, you can use it to determine your annual contribution and deduction limits. If you're self-employed, your income will probably vary every year, so it's crucial to recalculate these numbers annually or work with a tax professional.

4. Solo Roth 401(k)

A solo Roth 401(k) is a separate account within a regular solo 401(k) plan.¹⁰ It's a feature that's triggered when you make after-tax contributions to a solo 401(k).

As mentioned, you can make either after-tax contributions or tax-deferred pre-tax contributions to a solo 401(k), which means you'll pay federal and state income taxes on the money when you withdraw it after age 59½. One of the main advantages of making solo Roth 401(k) contributions is that you can enjoy tax-free growth on these contributions and not have to worry about paying taxes on it in retirement (as long as you make qualified distributions on or after age 59½). A drawback is that contributions to a solo Roth 410(k) aren't tax-deductible.

Another benefit is that there is no income limit to participate. A typical Roth IRA, on the other hand, bars many high-income earners from contributing, such as single filers with a modified adjusted gross income of more than $161,000 a year or joint filers with a modified adjusted gross income of more than $240,000 a year.¹¹

You can decide whether to make pre-tax solo 401(k) contributions, after-tax Roth 401(k) contributions or both. It's important to know you only can make employee Roth contributions in a solo 401(k). As an employer, you can match designated Roth contributions (for example, if you employ your spouse), but it will be on a pre-tax basis and subject to taxes later.¹²

A Look Down the Road

Freelancers now make up 39% of the U.S. workforce.¹³ This means millions of Americans will have to weigh retirement plan options for self-employed individuals and navigate how to set up a self-employed retirement plan.

Even if you run a successful business, that organization (and its liabilities) likely won't be your only retirement asset. A SEP IRA, SIMPLE IRA, solo 401(k) or solo Roth 401(k) could help you better prepare for your financial future — and potentially ensure the years of hard work you put into your business pay off with a comfortable retirement. A financial professional can help you consider your options.

Sources

1. Simplified employee pension plan (SEP). https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep.
2. COLA increases for dollar limitations on benefits and contributions. https://www.irs.gov/retirement-plans/cola-increases-for-dollar-limitations-on-benefits-and-contributions.
3. IRA FAQs: Distributions (Withdrawals). https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras#Distributions%20(Withdrawals).
4. SEP plan fix-it guide — contributions to the SEP-IRA exceeded the maximum legal limits. https://www.irs.gov/retirement-plans/sep-fix-it-guide-contributions-to-the-sep-ira-exceeded-the-maximum-legal-limits.
5. SIMPLE IRA plan. https://www.irs.gov/retirement-plans/plan-sponsor/simple-ira-plan.
6. SIMPLE IRA plan FAQs: Depositing and deducting contributions. https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-simple-ira-plans#depositing.
7. SIMPLE IRA withdrawal and transfer rules. https://www.irs.gov/retirement-plans/simple-ira-withdrawal-and-transfer-rules.
8. One-participant 401(k) plans. https://www.irs.gov/retirement-plans/one-participant-401k-plans.
9. 401(k) resource guide — plan participants — general distribution rules. https://www.irs.gov/retirement-plans/plan-participant-employee/401k-resource-guide-plan-participants-general-distribution-rules.
10. Roth comparison chart. https://www.irs.gov/retirement-plans/roth-comparison-chart.
11. 401(k) limit increases to $23,000 for 2024, IRA limit rises to $7,000. https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000.
12. Retirement plans FAQs on designated Roth accounts. https://www.irs.gov/retirement-plans/retirement-plans-faqs-on-designated-roth-accounts.
13. Upwork Study Finds 60 Million Americans Freelancing in 2022. https://investors.upwork.com/news-releases/news-release-details/upwork-study-finds-60-million-americans-freelancing-2022.