The Five Best Retirement Accounts for Self-Employed

The Five Best Retirement Accounts for Self-Employed

The Five Best Retirement Accounts for Self-Employed

Unlike workers, self-employed business owners and freelancers often need to figure out their retirement plans on their own.

While some of the rules and regulations surrounding IRAs and 401(k)s can appear a bit confusing, finding the right retirement plan for self-employed people is simple. 

What’s more, it’s even possible to create a match plan for employees if you own a small business that employs others. 

So let’s look at the five best retirement accounts for self-employed people to see which is right for you.

1. Traditional IRA

A traditional individual retirement account (IRA) lets you direct pre-tax income toward investments for tax-deferred growth. Capital gains and dividends taxes aren’t assessed until a withdrawal is made. 

The benefits of a traditional IRA include the following:

  • No income limit.
  • Tax-deferred growth. No taxes on earnings and contributions until required distributions begin at age 72. Money earned in a traditional IRA can also be deductible for the contribution’s tax year.
  • Traditional IRAs allow you to invest in nearly all stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
  • Unlike 401 (k) accounts, IRAs have early withdrawal exceptions that make it possible to take out money to cover expenses for college, adopting a child, buying a first home, and more.

A traditional IRA is a great choice for self-employed people who can benefit from the upfront tax break as an incentive to start saving for retirement. In addition, high earners get a benefit from the tax-deferred status. 

While the traditional IRA ultimately offers a “cheap” way to start saving for retirement, it does force you to face a tax burden in retirement that you can avoid with an individual Roth IRA.

2. Self-Directed IRA

A self-directed individual retirement account (SDIRA) is an IRA that allows you to invest in alternative assets prohibited by other IRAs. As the name implies, a self-directed IRA gives you full control over your investment decisions.

SDIRAs can be structured like a Roth or Traditional IRA, depending on your anticipated tax bracket at retirement. 

Like the traditional IRA, the SDIRA allows you to save for retirement on a tax-advantaged basis. 

However, SDIRAs offer greater flexibility regarding investments beyond stocks, bonds, mutual funds, and other common investments. For example, SDIRAs permit investments in:

SDIRAs are advantageous because they allow for high returns and also greater diversification. Of course, investing in alternative assets also comes with a bit of risk. 

Almost anyone can open an SDIRA. However, using a federally insured trustee or custodian specializing in SDIRAs is important. 

Be sure to research self-directed IRA investment rules before investing.

3. SEP IRA

Designed for both self-employed workers and small-business owners, Simplified Employee Pension (SEP) plans allow you to set aside income for retirement without the enrollment and operating fees of conventional retirement plans. This is a common option when setting up a simple match plan for employees. 

The SEP-IRA rule allows account holders to invest up to 25% of an employee’s compensation (up to $61,000 in 2022), making this a great choice for high-earning individuals. Here’s a rundown on how SEP IRAs work:

  • Eligible participants are employees over age 21 who have worked for an employer for at least three of the past five years.
  • Eligible employees must have earned at least $650 during 2021 and 2022.
  • Employers must match all self-directed distributions for enrolled employees. For instance, an employer who stashes away 10% of their own compensation must contribute 10% to each employee’s compensation.

A SEP IRA can be combined with traditional and Roth IRAs, and all contributions are deductible. There is no commitment to contribute every year after opening a SEP IRA. No catch-up contribution option exists for people aged 50 and over with the SEP.

4. SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA is a tax-deferred employer-sponsored retirement plan designed for small businesses with less than 100 employees. 

A SIMPLE IRA allows an employer to make either non-elective contributions of 2% of each employee’s salary or dollar-for-dollar matching contributions of each employee’s contributions (up to 3% of salary). 

While the maximum annual employee contribution for the SIMPLE IRA is $14,000 (2022), employees reaching age 50 and over can make additional catch-up contributions of $3,000. 

5. Solo 401 (k)

Designed for self-employed business owners, the solo 401(k) offers many of the same features as employer-sponsored retirement plans. 

In order to contribute to a solo 401 (k), you must be a business owner with no employees. While the maximum contribution on the solo 401 (k) is $61,000 (2022), there’s a $6,500 catch-up contribution option if you’re age 50 or older. 

A solo 401 (k) can be opened as either a traditional or Roth account. With a traditional solo 401 (k), contributions are made on a pre-tax basis to reduce your tax burden. Roth 401 (k) contributions are made with after-tax dollars. 

IRA Contribution Limits

IRA contribution limits are routinely adjusted for inflation. Typically, limits are determined using either a capped figure or salary percentage. Here’s a rundown of current IRA contribution limits for self-employed IRA options (2022):

  • Traditional IRA: $6,000 ($7,000 over age 50).
  • SDIRA: $6,000 ($7,000 over age 50).
  • SEP IRA: 25% of compensation/$61,000.
  • SIMPLE IRA: $14,000.
  • Solo IRA: $20,500 ($27,000 over age 50).

When considering any type of IRA, it’s important to factor in income bracket, expanded contribution allotments for age, and other stipulations that could allow you to invest the maximum amount possible while receiving a tax advantage on your employment income.

Which Self-Employed Retirement Plan Is Right for Me?

The Traditional IRA is a great starting point for someone who simply wants to start putting money in a retirement account when they don’t have any kind of savings incentive match plan from an employer. 

However, self-employed people with high-income levels or employees should consider an SDIRA, SEP IRA, Simple IRA, or solo 401 (k) to discover which features allow them to save for retirement while enjoying the biggest tax deduction. 

Self-employed people catching up with retirement savings should also consider plans that increase maximum contributions after age 50.

Finally, everyone who earns income should open a retirement account. For self-employed people, a retirement plan can allow you to take a tax deduction on your tax return, reducing your taxable income. 

For small-business owners, matching contributions can help elevate their status as desirable employers while providing them with a tax advantage.