Retirement Plan Options for the Self-Employed

Self-employed individuals have the autonomy to choose when and how they work. But they also have to take the initiative to prepare for their own retirement. Entrepreneurs have several options to save for retirement, some of which qualify for tax benefits. Consider these retirement plan options for your small business.

Traditional or Roth IRA. Individual retirement accounts have low contribution limits, but deposits qualify you for tax perks. You can defer paying income tax on up to $6,000 that you contribute to a traditional IRA in 2019, and the contribution limit climbs to $7,000 if you are age 50 or older. You could deposit up to the same amount in an after-tax Roth IRA and set yourself up for tax-free investment returns and tax-free withdrawals in retirement. You can save in a traditional and Roth IRA in the same year as long as your total deposits in both types of accounts don’t exceed the annual contribution limit.

IRAs aren’t associated with an employer, so you can continue to use the same IRA regardless of where you work. “The IRA can be most appropriate for those just starting out or only able to save less than $6,000 per year, or $7,000 if over 50,” says Rick Vazza, a certified financial planner and president of Driven Wealth Management in San Diego. IRA contributions aren’t due until your tax filing deadline in April, so you can plug in a contribution while preparing your taxes to see exactly how much your tax bill will decline.

[Read: How to Use Retirement Accounts to Reduce Your Tax Bill.]

Solo 401(k). A solo 401(k) is a single participant 401(k) plan that covers a business owner with no employees and his or her spouse. Contributions to a solo 401(k) can be made as both an employer and a participant. You can defer paying income tax on up to $19,000 in 2019, or $25,000 if you are age 50 or older, that you deposit in a solo 401(k). “For those over 50, you can make a $6,000 catch-up contribution to a solo 401(k) plan,” says David Rae, a certified financial planner and president of DRM Wealth Management in Los Angeles.

As an employer, you can additionally contribute up to 25 percent of compensation to the solo 401(k), after subtracting your personal contributions and half of your self-employment tax. The maximum possible contribution is $56,000 in 2019, or $62,000 for those age 50 and older. “The primary advantage of the solo 401(k) over the SEP IRA is that you have the benefit of funding the plan both as the employer and employee,” says Stephanie Sammons, a certified financial planner and founder of Sammons Wealth Management in Dallas. “That means, in most cases, you’re going to be able to sock away much more of your earnings for retirement with a solo 401(k) and grab a bigger tax deduction as well.”

[Read: Defeating Retirement Challenges When Self-Employed.]

SEP IRA. Small business owners with a few employees can establish a simplified employee pension plan. “If you have any additional employees who work more than 1,000 hours per year, the SEP IRA would likely be a better option,” Sammons says. Only employers can contribute to SEP IRAs and must contribute an equal percentage of salary for all eligible employees. So, if you contribute 10 percent of your pay to a SEP IRA, you must also contribute 10 percent of salary for each employee. Business owners can defer income tax on as much as 25 percent of compensation up to $280,000 using a SEP IRA, for a maximum possible contribution of $56,000. “Catch-up contributions are not allowed on SEP IRAs,” Rae says.

[See: How to Pay Less Taxes on Retirement Account Withdrawals.]

SIMPLE IRA. A savings incentive match plan for employees has a lower contribution limit than many other types of retirement accounts. However, these accounts for businesses with 100 or fewer employees are generally easy to set up and manage. The employer must contribute to a SIMPLE IRA, and individual employees can choose to save more in the plan. Employers are generally required to contribute 2 percent of an employee’s pay up to $280,000 in 2019 or provide a dollar-for-dollar match up to 3 percent of each employee’s salary. An employee can elect to defer paying taxes on up to $13,000 that is deposited in a SIMPLE IRA in 2019, and workers age 50 and older can make catch-up contributions of an additional $3,000.

The ideal retirement account for self-employed workers depends on how much you will be able to save, whether you have employees and the amount of administrative complexity you are willing to take on. “While administrative requirements should not be the sole reason of deciding on an account, it is a factor that needs to be considered,” Vazza says. “Contribution limits, age, taxation and ongoing administration will be important factors in determining the right account option.”

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