Retirement plans for the self-employed
August 18, 2021

Retirement planning may be a little different for the self-employed, but it’s just as important, if not more so.

60% of working Americans have access to a 401k plan through their employer.  But if you are among the nearly 10 million self-employed, you are entirely responsible for your retirement plan. There are other types of income to support you in retirement; Social Security, pensions, part-time work, rental and other types of passive income supplement your savings and investment income. However, IRAs and 401(k)s offer tax benefits and contribution flexibility that could make them the cornerstone of your retirement plan.

As an independent, self-employed person you have a number of sound options when it comes to retirement planning.  Here are some plan types to consider and discuss with your accountant or financial advisor.

1.     Traditional or Roth IRA – This is available for employees for the self-employed and often suggested for those starting out. The annual contribution limit in 2021 is $6,000, or $7,000, if you’re age 50 or older. While there’s a tax deduction on traditional IRA contributions, there’s no immediate deduction for Roth IRA contributions. When you begin withdrawing from your Roth, those funds are not taxed.

2.     Solo 401K – This plan type is for a business owner or the self-employed with no employees. The total contribution limit of $58,000 is comprised of two parts:

·        As the employee you can contribute up to $19,500 in 2021 or 100% of earned income, whichever is less, plus a $6,500 catch-up for those 50 or older.

·        As the employer, you can also make an additional contribution of up to 25 percent of your salary. In 2021, the compensation limit that can be used to determine your contribution is $290,000.

You can also choose a solo Roth 401K, which like a Roth IRA might be a wise choice if you expect your tax rate and income to be higher in retirement than they are now.

3.     SEP IRA – This is designed for self-employed people or small-business owners with few or no employees. With the SEP IRA, the contribution limit is the lesser of $57,000, in 2020, or up to 25 percent of compensation or net self-employment earnings, with a $285,000 limit on compensation that can be used to determine the contribution. There’s no provision for a catch-up contribution.

The tax advantage here is that you can deduct the lesser of your contributions or 25 percent of net self-employment earnings or compensation – capped at $285,000 per employee, for 2020 – on your tax return. When you begin deducting those resources, that income is taxed.

If you have employees, you must contribute an equal percentage of salary for each eligible employee, and you are counted as an employee. So, if you contribute 10 percent of your salary, you must do the same for your employees. Another disadvantage is that like all IRA-based plans, participants cannot borrow from their vested balance.

4.     Simple IRA – This plan is often favored by larger businesses, with up to 100 employees. The contribution limit is up to $13,500 in 2021, plus a catch-up contribution of $3,000, for those 50 and older. For those who also contribute to an employer IRA plan, the total of all contributions can’t exceed $19,500.

The tax advantage here is that the contributions are deductible, but distributions during retirement are taxed.  In other words, a Simple IRA cannot be a Roth IRA.  Contributions to employee accounts are deductible as a business expense.

5.     Defined Benefit Plan – This is a retirement plan best for a small business with no employees, high earnings and the desire to create current tax year savings. Contributions are typically tax deductible, with distributions being taxed after retirement. Because the annual fees and setup costs are high, check with your accounting or financial adviser as to whether the tax advantages could be worth the charges.

Being an independent business owner brings responsibilities along with freedom.  Managing your retirement is just one of the many important tasks that are in your hands, but we are ready to help you choose the best employer retirement plan for your small business.  Together we’ll consider all future retirement income sources and help you with important decisions like when to take Social Security, whether to consider a Roth Conversion and how to plan for RMDs.  Give us a call.


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Diamond & Associates CPAs