Self Employed Retirement Plans: Here Are Your Options

There are all types of self-employment and all types of ways to set aside money for retirement.

However, many individuals in self-employed jobs fail to allocate funds for retirement, believing they lack both the time and the financial resources to do so.

Neither is true. You can start a retirement account with any amount of money – the most important thing is to start. And we’ll cover the nuts and bolts of the various options for a self employed individual.

What is a Self-Employed Retirement Plan?

Individuals with employers often have retirement plans like an IRA or a 401(k). Those who are self-employed can also access similar types of plans, which are straightforward to establish.

Funding retirement for self employed individuals isn’t something to be feared, or avoided. The sooner you start, the sooner those accounts will begin to grow.

How to Choose the Best Self-Employed Retirement Savings Option

As a self-employed person, you’re also a business owner. That gives you options regarding contribution limits for certain plans. We’ll cover the details of the retirement plans later. In the meantime, here are things to keep in mind as you learn more:

1. Before Tax? – If you choose to contribute earnings from self-employment before those earnings are taxed, the amount you contribute will be subtracted from your gross income (called modified adjusted gross income) when you file taxes. When you withdraw the money, it will be taxed.
2. After tax? – If you choose to contribute money that has been taxed, you can later make tax-free withdrawals.
3. Amount of contribution – If you choose an IRA, your annual contribution limit is set at $6,000 for a single person (or $7,000 the first year you open the IRA as a catch up contribution). If your earnings from self employment are high, you may want to choose retirement savings with higher contribution limits, such as a 401 k or Keogh.
4. Your age – If you’re relatively young, you may opt for an IRA or 401(k) along with a Health Savings Account. You can contribute $3,650 to an HSA, and you can withdraw that money tax-free as long as it is used for medical expenses. If you have a high income or are more senior, you may decide to rapidly increase your retirement savings with an account like a Keogh. With a Keogh, you determine the schedule for the timing and amount of contributions.

Retirement Accounts for Self-Employed

Here are the details for self-employed retirement planning.

Self-Employed 401k

As a self-employed person, you’re both an employee and an employer. Although it’s a solo 401 k, you can make contributions as both employee and employer contributions. That makes the solo 401k a top choice in plans for retirement for self-employed individuals.

Contribution Limit: The employee contributions to the 401 k can be up to $19,500 (plus another $6,500 if you’re more than 50 years old). The employer’s contribution can bring that solo 401 k annual contribution up to a $55,000 total.

Tax Benefits: Contributions to a solo 401 k are on a pre tax basis and are deducted from your gross income.

Self-Employed IRA (Simplified Employee Pension or SEP IRA)

The SEP IRA is structured differently from the traditional (or Simple IRA) and Roth IRAs.

To start a SEP IRA, you must earn less than $122,000 as a single person or $193,000 married.

Contribution Limit: The contribution limits are up to 25% of earnings, based on the standard income limits.

Tax Benefits: Contributions are pre-tax dollars and deducted from gross income.

IRAs

For a simple IRA retirement account there are two kinds, traditional (Simple IRA) or Roth IRA. Either is easy to start and often offered by an investment company or financial institution.

With the Roth IRA contributions are taxed before they are contributed and part of net self employment earnings. That means that the Roth IRA monies are not taxed when withdrawn.

With a traditional IRA, contributions are pre tax dollars and subtracted from gross income. When withdrawn from the traditional ira retirement account, the monies are taxed.

Contribution Limit: $6,000 a year ($7000 the first year as a catch up contribtion) annually. If you want to contribute more, then a 401 k may be a better choice ($19,500).

Tax Benefits: The pretax contribution for a traditional IRA is pre-tax and deducted from gross income taxes. With the Roth IRA, contributions are after-tax dollars. You won’t pay taxes on the Roth IRA monies when you withdraw them.

Self-Employed Social Security

Money goes into this account via self employment taxes. This is in additional to income tax. Self employment taxes are 15.3%, with 12.4% for social security and 2.9% for medicare.

Contribution Limit: If you earn more than $400 a year, you must pay self-employment tax. The amount you contribute will be based on your net earnings. Half of the social security tax is generally tax deductible since “normally” half would be paid by an employer contribution.

Profit Sharing Plan

A profit-sharing plan is also called a Keogh plan. As an employer, you make contributions.

The profit sharing or Keogh plan is like a pension, but you as employee can figure out what you’d like to receive yearly as part of your retirement plans. Based on that goal, you create a schedule of contributions.

As an employer, you can use a Keogh plan to make contributions to employees’ accounts. If you do so, that amount is tax deductible from your business’s taxable income.

Contribution Limit: The maximum annual benefit is a contribution of up to $225,000.

Tax Treatment: The amount you contribute to your account is on a tax deferred basis. The amount you contribute to employees as a business owner is deducted from the business’s taxable income.

Money Purchase Plan

Money purchase plans are also known as defined benefit plans. A defined benefit plan is a top choice if you’ve started saving late and want to make a catch-up contribution to a plan.

You establish the plan with a specific amount designated for the annual contribution limit. This annual contribution allows for tax-deferred growth.

As an employer, you can provide a money purchase plan as part of the compensation for eligible employees, contributing funds directly into their individual retirement accounts. These defined contribution plans do not have an annual compensation limit; you have the flexibility to determine the contribution amount.

Contribution Limit: The limit is set by the employer.

Tax Benefits: Small businesses owners can offer a Money Purchase Plan as a perk. If an employee leaves the company the money can be rolled over into other retirement plans, received as a lump sum or used to purchase an annuity.

Savings Incentive Match Plan for Employees

This is also called SIMPLE by its initials. The SIMPLE Plan can be established by one person or for employees as a workplace retirement plan for a small business with fewer than 100 employees.

Either way, the SIMPLE retirement plan has a tax advantage for business owners. Each employee who earns $5,000 or more can have an individual retirement account which the employer funds.

Contribution Limit: Up to 3% of annual income is the maximum employer contribution.

Tax Benefits: Small business owners who provide self-employed retirement plans to their employees can receive a tax deduction corresponding to the contributions made by the owner. Additionally, it serves as a valuable benefit to include in employee compensation packages.

Health Savings Account

It’s important to realize this requirement for starting an HSA – your health insurance plan must have a deductible of $1,350 or higher ($2,700 for family plans).

If you’ve maxed out your annual contributions to traditional and roth iras, sep iras or 401 ks, an HSA has tax advantages. You are contributing pre tax dollars, which are subtracted from your gross income.

Contribution Limit: $3,650 for a single person, $7,300 for families.

Tax Benefits: You can withdraw funds from your HSA tax-free if the money is used for medical expenses, which include health, vision, and dental costs. Once you reach the age of 65, you can use the funds for any purpose; however, those withdrawals will be taxed at your ordinary income rate.

How to Open a Self-Employed Retirement Plan

Your first step is to choose the plan that fits. You have to consider things like how much you can afford to contribute, given your personal financial situation and goals. If you want to contribute a more significant amount than the $6,000 IRA, you need a plan where you can make additional catch-up contributions.

One of the best sources for learning more before you make that decision is the IRS.

Managing Your Retirement Funds

Some plans are simple to start, but to get the best value from your funds, you should consult a financial advisor.

With a 401 k, you can start making withdrawals at age 59 1/2. With SEP IRAs, Roth, and traditional IRAs, you must make the required minimum distributions at age 70 1/2 or 72 (depending on your date of birth).

You need a plan for how you’ll use that money after withdrawals.

What is the best retirement plan for self-employed people?

A traditional or Roth IRA is an easy way to get started. The first year, you can make an additional catch up contribution of $1,000 in addition to the annual maximum $6,000. Contributions will be deducted from your gross income, which will reduce the taxes you pay on your net earnings from self-employment.

With the SEP-IRA or self-employed 401 k, the annual self-employed employee contribution can be higher.

The HSA makes great sense. Some of the most affordable health care plans are affordable because they come with high deductibles.

How much can a self-employed person put away for retirement?

There are no limits. The amount you can save depends on the type of retirement plan product you can afford and choose.

Do self-employed pay social security?

Yes. Social security is paid as part of self-employment tax. The self employment tax is 15.3%, with 12.4% for social security and 2.9% for medicare.

Is an IRA better than a 401k?

Both are funded with pretax dollars and taxed at withdrawal. The contribution limit for an IRA is $6,000. A 401 k can be “double funded” by you as employer and employee, up to $55,000 total annually. If you can afford it, you can save more faster with a 401k. Also, you can have both types at the same time.

You can hold multiple IRAs; however, the total annual contribution across all your IRA accounts is capped at $6,000.

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