Saving for retirement can be hard enough, but self-employed workers don’t have the benefit of an employer-sponsored 401(k) that automates savings. If you’re self-employed, you’ll have to take your own action to ensure you have enough money for a comfortable retirement.
Self-employed individuals should carefully structure their budgets to make sure they don’t forget retirement savings. Additionally, finding the best account for your retirement savings — whether that’s a Roth IRA or Solo 401(k) — means you can still take advantage of tax benefits on the way.
[READ: Deciding Between a Roth vs. Traditional IRA.]
How Does Retirement Planning Differ for Self-Employed Workers?
Most budget advice assumes that a saver’s retirement funds are automatically being deducted from their paychecks — but that simply isn’t the case for all workers.
“When you are self-employed, you have an added barrier to retirement savings than many corporate employees. You won’t have a workplace retirement plan to simply opt into. Rather, you need to consider and set up your own retirement savings account,” Amy Ouellette, certified financial planner and vice president of Vestwell, says.
Not only do self-employed workers have to budget for their own taxes and health care, they also have to consider retirement savings when allocating their incomes.
Self-employed individuals are similarly responsible for researching the best retirement accounts for them, rather than just accepting what an employer provides.
Retirement Plan Options for the Self-Employed
According to Stuart Boxenbaum, CFP and president of Statewide Financial Group, 401(k)s are certainly the easier retirement option thanks to automatic deductions — but that doesn’t mean they’re the only one available.
“The most important thing is determining what will give you the largest tax deduction and affordable contribution. Which I would recommend depends on the situation of you and your family,” he says.
Retirement plans for the self-employed include:
— Traditional or Roth IRA.
— Solo 401(k).
— SEP IRA.
— SIMPLE IRA.
Traditional or Roth IRA
IRAs, or individual retirement accounts, are a good options for retirement saving because they offer tax benefits. Since they aren’t tied to an employer, self-employed workers can contribute regardless of where they work. The biggest drawback of this kind of account is the low contribution limit — $6,500 per year in 2023 for those younger than 50 and $7,500 for those older than 50.
The difference between a traditional IRA and Roth IRA is that traditional IRA contributions are made pretax, while Roth IRA contributions are made with taxed income. In retirement, Roth IRA funds can be withdrawn tax-free.
Solo 401(k)
“Solo 401(k) plans are 401(k) plans available to an owner-only business, such as a sole proprietor or consultant. They allow for deferrals (money contributed out of salary) and employer contributions (money paid from employer accounts, e.g., profit sharing),” Ouellette says.
Solo 401(k)s can be a good choice for self-employed workers looking for a plan that works similarly to a traditional 401(k) and with larger contribution limits than an IRA. You can contribute as both the employee and the employer with these plans, allowing you to save a lot more.
As an employee, you are subject to a contribution limit of $22,500 each year as of 2023 (or $30,000 if you are 50 or older). As an employer, you can contribute up to 25% of compensation as long as your total contributions don’t exceed $66,000.
Plus, if you’re currently a sole proprietor but hope to grow your business in the future, you could convert your solo 401(k) to a standard 401(k) down the road, Ouellette says.
[READ: Ways to Avoid 401(k) Fees and Penalties]
SEP IRA
A SEP IRA is another great option for self-employed individuals who don’t plan to hire many employees.
“A Simplified Employee Pension IRA (SEP IRA) is a type of traditional IRA for self-employed people or small-business owners with employees. A SEP plan allows employers to contribute to a SEP IRA account set up on behalf of the owner or employee. SEP plans are most commonly offered by sole proprietors or other self-employed individuals,” Ouellette says.
The biggest difference to note in a SEP IRA plan versus a 401(k) is that only employers can make contributions — not employees. You can contribute up to 25% of compensation or $66,000 per year, whichever is lower. Contributions are tax deductible.
SIMPLE IRA
A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a type of plan designed for small businesses, making it a good choice for sole proprietors or self-employed individuals who plan to grow their businesses in the future.
Similar to a 401(k), employees with a SIMPLE IRA can set up automatic paycheck deductions toward this account, while employers contribute 2% to 3% for all eligible employees, depending on employee contributions.
If you’re a sole proprietor, you can make contributions as both employee and employer. The employee contribution limit for a SIMPLE IRA is $15,500 as of 2023 (plus $3,500 in catch-up contributions for those over 50). For employers, the max contribution is 3% of your net earnings as matched dollar-for-dollar to employee contributions, or 2% of your earnings otherwise (max of $330,000 in 2023).
[READ: 10 of the Best-Performing 401(k) Funds.]
Prioritizing Retirement Savings When You’re Self-Employed
Setting up a retirement account is only the first step toward savings for self-employed workers. You’ll also need to actively prioritize putting money away.
According to Boxenbaum, self-employed individuals should start by consulting with a professional to determine how much they should be saving. “For self-employed workers prioritizing retirement savings, the easiest way to get started is first confirming with an advisor or tax professional how much can be contributed annually into a retirement account,” he says.
One rule of thumb is to save 10% of your income, but that will vary based on the type of retirement account you choose, plus your age and amount of disposable income.
Once you have a savings goal in mind, you can make the savings process easier by automating savings. Automatic deposits to your accounts can mirror the setup of a traditional 401(k) so you don’t have to remember to set aside the money.
“If you are not able to set up automated withdrawals to a 401(k) plan, then setting up regular deposits into other retirement plans, such as SEP and SIMPLE IRAs, can help you achieve the same goal of consistent savings and growth,” says Michael Collins, chief executive officer and founder of WinCap Financial and chartered financial analyst at Endicott College.
Finally, Collins stresses the importance of regularly reviewing your contributions as your income grows. He recommends checking in on your goals when your earnings or expenses change as well as making sure the retirement plan you are using is still the best choice for you.
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Guide to Retirement Planning for the Self-Employed originally appeared on usnews.com
Update 04/12/24: This story was published at an earlier date and has been updated with new information.
