The Solopreneur’s Guide to Retirement Funds

Can a self-employed person save for retirement on their own?

The answer is yes, and there are several plan types they can use, such as a solo 401(k) or an IRA. But are solopreneurs saving for retirement? According to a recent Federal Reserve study, just 36% of adults who are not retired think they are on track with their retirement savings. That means a large swath of the population, including self-employed workers, are not saving enough for their future. 

Saving on your own is possible, but it’s not always as easy as participating in an employer-sponsored retirement plan, and a simple savings account isn’t going to cut it. If you stow away money in a bank account, you get extremely low interest rates, which currently will keep pace with inflation. On top of that, the interest you earn from your savings account is taxed as regular income. This means that if you earn $1,000 in interest and are in a 24% tax bracket, $240 of your interest will go to taxes. If you want to earn a higher return on your savings, you need to put your money in an investment vehicle. 

Can you have a 401(k) if you are self-employed? 

You may not be able to have a regular 401(k), unless you have employees and decide to sponsor an employee retirement plan, but you can have a solo 401(k). It works a lot like a 401(k) plan, only you are treated as both the employee and employer. 

With a solo 401(k), you can make elective deferrals from your pay of up to $20,500 (as the employee) if you are under 50 years old in 2022. If you are over 50, you can contribute $27,000. Then you can make additional contributions (as the employer) for a total contribution (employer and employee) of $61,000 in 2022. Many brokers offer this plan for a small or no fee. You also have the option to set up a self-employed 401(k) for your spouse if you co-own the company.  

“You can also make a profit-sharing contribution from the business, in which the dollar amount depends on how your business is structured and your pay,” Nick Strain, senior wealth advisor at Halbert Hargrove, told business.com.   

Like traditional 401(k) plans, solo 401(k) plans have both pre- and post-tax versions. A Roth 401(k) allows you to make contributions after your taxes have been deducted. This means you can make tax-free withdrawals upon retirement. On the other hand, pretax 401(k) contributions are made with before-tax dollars, so you will be taxed on the money when you withdraw it. 

How do you get started with a 401(k)?

Find a 401(k) fund directly through a financial investment firm that offers the type you want. The investment firm will ask you to designate an administrator for the self-employed 401(k) plan. Depending on the firm’s rules, you may not be allowed to act as the administrator, but you could designate your accountant.

According to TD Ameritrade, you will fill out two forms: a 401(k) application and an adoption agreement. Upon approval, the provider will give you a schedule to calculate your annual contributions. You’ll mail checks to the investment firm, along with a 401(k) remittance form. You may be able to roll over other investments into your self-employed 401(k). Financial products that may be eligible for transfer include IRAs, 403(b) plans and 457(b) government plans.  

Who can use a solo 401(k)?

A solo 401(k) is best for self-employed individuals who have no employees (excluding a spouse) and do not plan to hire any. It’s also important to have stable cash flow so you have enough cash to make contributions.

Do you get a pension if you are self-employed? 

When you think of retirement, you may think of pensions, which are a type of defined-benefit retirement plan. With a pension, your employer pays you a guaranteed monthly amount after you retire, but unlike with 401(k) plans, the value of the account isn’t dependent on the performance of your investments. As a self-employed business owner, you do not get a pension. 

Fortunately, in true solopreneur fashion, you can set up a personal defined-benefit plan. This allows a high-income business owner to save more than the $61,000 limit on self-employed 401(k) plan contributions for 2022, Strain said.  

The personal defined-benefit plan can help you save $100,000 to $300,000 a year. Your annual income determines the savings amount. Through this plan, contributions decrease your annual taxable income and can save you a lot of money on taxes.  

“Once the [self-employed] business owner grows their retirement assets and they’re ready to retire, they can purchase an annuity through an insurance company for all or part of their retirement savings to create a pension and guaranteed monthly amounts to receive for life,” Strain said.  

But buyer beware: Before you purchase an annuity, speak with a trusted advisor – someone who isn’t selling an annuity and will not make a commission on it – to find out if this is a good option for you. Annuities are notoriously problematic, and you’ll pay much more in fees compared to other investment vehicles. 

Who can use a personal defined-benefit plan? 

A personal defined-benefit plan is designed to help individuals quickly increase their retirement assets. As a result, it’s best for high-earning business owners with few or no employees. Solopreneurs typically use this plan during their peak earning years.

How much can a self-employed person contribute to an IRA?

There are several kinds of IRAs – individual retirement accounts – that you can use as a solopreneur. Traditional and Roth IRAs are the most popular types, as nearly anyone can use them, but there are also SIMPLE IRAs and SEP IRAs, which are available to sole proprietors only. One benefit of these retirement savings accounts is that you have more time to invest. You can contribute to an IRA for a given year up to April 15 (the tax filing deadline) of the following year. 

What is a traditional IRA?

A traditional IRA is a retirement savings account that has tax advantages. It may minimize your tax bill, because when you make a contribution, it reduces your taxable income for the year. Investments are tax-deferred, meaning you invest pretax dollars and nothing is taxed until you withdraw it. You must wait until you’re 59.5 years old to make withdrawals. Otherwise, you must pay a 10% distribution penalty, and the money will be taxed as ordinary income. One exception to this rule is that you can withdraw up to $10,000 for a home purchase with no penalty. 

You must have taxable income to contribute to a traditional IRA, but there are no longer age restrictions (before Jan. 1, 2020, individuals over the age of 70.5 could not contribute). According to the IRS, the IRA contribution limit for 2023 is $6,500. If you’re over the age of 50, you can contribute an additional $1,000, for a maximum contribution of $7,500. 

Who can use a traditional IRA? 

A traditional IRA makes more sense than a Roth IRA if you expect to have less income in retirement than you do today. With a traditional IRA, your yearly contributions reduce your taxable income, which can lower your tax bill during your high-earning years. You do have to pay taxes on IRA retirement distributions. 

What is a Roth IRA?

A Roth IRA allows you to invest with after-tax dollars, meaning you have already paid income taxes on the money you contribute to this account. Since the money has already been taxed, it’s allowed to grow tax-free, and you won’t have to pay any taxes on eligible withdrawals from your account (though you must wait until you’re 59.5 years old and your Roth IRA has been open for at least five years). There are no minimum deductions for Roth IRAs. 

For you to be eligible to open and contribute to a Roth IRA in 2022, your modified adjusted gross income must be $144,000 or less if you’re a single filer and $214,000 if you are married and filing jointly. 

The maximum contribution for a Roth IRA in 2022 is $6,000. If you’re over the age of 50, you can make a catch-up contribution of $1,000, for a maximum contribution of $7,000. 

Who can use a Roth IRA? 

A Roth IRA makes sense if you expect to have more income in retirement than you do today. With a Roth IRA, you pay taxes upfront on contributions, but deductions are tax-free. Once you begin to withdraw, you won’t have to worry about paying taxes on any gains. 

What is a SIMPLE IRA?

SIMPLE stands for “savings incentive match plan for employees.” A SIMPLE IRA plan operates a lot like a regular IRA, but it has a much higher contribution limit. A sole proprietor can set up a SIMPLE IRA for themselves and contribute to it as both the employer and the employee. 

You must have earned at least $5,000 from your company the previous year to be eligible for a SIMPLE IRA. The contribution limit for a 2022 SIMPLE IRA is $14,000. If you’re older than 50, you can make a catch-up contribution up to $3,000, for a maximum contribution of up to $17,000.

Who can use a SIMPLE IRA? 

A SIMPLE IRA is a low-cost way to offer employees a retirement savings vehicle. This makes sense for small businesses with fewer than 100 employees. The company cannot sponsor another retirement plan. 

What is a SEP IRA?

A SEP IRA, which stands for “simplified employee pension,” is ideal for small business owners because it doesn’t require much paperwork or maintenance and allows you to vary the amount you contribute each year. 

Those who are eligible to participate in a SEP IRA plan include sole proprietors and business owners in a partnership or limited liability company like an S corporation or C corporation. In addition, you must be at least 21 years old, have been self-employed for the past three years, and have earned $600 or more in self-employment income. The contribution limit for 2022 is either 25% of your salary or $61,000 (whichever is less). 

Who can use a SEP IRA? 

A SEP IRA makes sense for business owners who want a basic retirement plan without yearly contribution requirements. It allows you to adjust contributions based on your cash flow. 

How do you get started with an IRA?

You need to find a brokerage firm that offers the type of IRA you’re interested in setting up. The firm will advise you on the rules for contributions and which accounts you are eligible to roll into the fund. (SIMPLE IRAs usually require less paperwork than other types of retirement accounts.) Once you open your IRA, you’ll fund it through initial contributions and any other rollover assets, such as IRAs and 401(k) plans. What is a Keogh plan?

According to the IRS, the term “Keogh plan” was previously designated to retirement plans for self-employed individuals. Keogh plans are now often referred to as “H.R. 10 plans.” Both self-employed workers and unincorporated business structures can use a Keogh plan. It’s a tax-deferred pension featuring two distinct plan options: defined benefit and defined contribution. 

With a defined-contribution Keogh plan, you make contributions on a regular basis until the fund reaches the maximum amount. With the defined-benefit type, the Keogh plan has a stated amount of benefits that you’ll receive at retirement age. The benefits are normally calculated by the number of years worked and salary amounts. A maximum annual benefit is set for this type of Keogh plan. 

For both of these plans, withdrawals start after age 59.5 and before age 70.5. Contributions are tax-deductible up to a certain percentage and subject to change year to year, according to current IRS regulations. Both allow high contribution limits, with defined-contribution plans permitting 25% of salary or $61,000 for 2022 and a defined-benefit plan allowing $245,000 for 2022.

Who can use a Keogh plan? 

Keogh plans are best for high-earning solopreneurs looking to make bigger contributions than they can with a SEP IRA or 401(k) plan. These plans tend to be more complicated to administer and typically have higher maintenance costs. 

How do you get started with a Keogh plan?

A Keogh plan must be filed before the end of the tax year or when you’d like to receive the deduction. Since Keogh plans require extensive paperwork, you should enlist the help of a CPA. You’ll need to file IRS Form 5500 each year to qualify for the Keogh plan.

Which retirement plan is specifically designed for self-employed individuals and their employees? 

Business owners with employees have multiple retirement savings options as well, including traditional 401(k) plans,SEP IRAs and SIMPLE IRAs.  

A traditional 401(k) plan is one of the most popular options for businesses with employees because it allows employees to contribute more money, and they can often choose between pretax and Roth contributions.  

Small business owners with employees can also use a SEP IRA. You can open one through an online broker, and it doesn’t require annual tax filings with the IRS. You don’t have to contribute to employee accounts every year, but if you have multiple participants, you must contribute the same percentage to each of them.  

A SIMPLE IRA can be used by businesses with up to 100 employees and, like a SEP IRA, is easy to maintain, with no annual tax filings. A SIMPLE IRA demands more paperwork than a regular IRA, though, and although contributions are flexible, you must match employee contributions or contribute to employee accounts.  

Simone Johnson contributed to the writing and reporting in this article. Source interviews were conducted for a previous version of this article.