What Are the Best Self Employed Retirement Plans?

November 25, 2020 By Richard Poulson

Being self-employed has a lot of advantages. You are your own boss, you set your schedule, and there's no cap on what you can earn if you work hard. Those are all wonderful things.

The downside of self-employment includes, paying out of pocket for health insurance, life insurance, and -- most importantly for many people -- your retirement plan.

At Cook Martin Poulson, many of our self-employed clients want to know the answer to this question: 

What are the best self-employment retirement plans?

We're here to provide the answers. Self-employed retirement plans are not a one size fits all approach. In this post, we'll explain options that will help you determine what will be best for you and your family.


Why Set Up a Retirement Plan?

Do you need to set up a retirement plan? You may be wondering if it's necessary to have a retirement plan. Many of our younger clients ask us whether there's any real urgency when they expect to be working for decades. Is it acceptable to wait?

The short answer is no. Life is unpredictable. If you wait to set up a retirement plan, you may find that you don't have time to save the money you will need for a happy and comfortable retirement.

Here are some of the advantages for setting up a self-employment retirement plan now instead of later.

  • Acting now enables you to take advantage of compound interest. Which allows you to earn interest on the returns on your investments -- a key to growing your savings.
  • Early saving also means that you'll start saving at a time when you can take more risks. Potentially making more money on your investments. Investing in stocks is a long-term strategy and you can be patient if you start young.
  • Financial security during retirement years.
  • Ultimately, very few of us want to face the prospect of being required to work for the rest of our lives.


Types of Self-Employed Retirement Plans: Know Your Options

The good news is there are multiple options available. Here are the five types of retirement plans you can set up:

One Participant/Solo 401(k)

The first plan to consider is the solo 401(k). Which is designed for people who are self-employed without any employees. You can contribute both the employee's portion and an employer's portion, which allows you to contribute far more than you could with most other types of employer-sponsored plans.

With a solo 401(k), there are tax advantages regardless of which plan type you choose. A traditional solo 401(k) allows you to contribute pre-tax funds. While a Roth solo 401(k) allows you to contribute post-tax funds that you may later withdraw tax-free.

Here are the advantages of a solo 401(k) plan if you're a sole proprietor:

  • You can contribute a significant portion of your income that will allow your retirement funds to accrue quickly.
  • You have the option of contributing money pre-tax or post-tax depending on your preferences.
  • Your spouse may contribute money to the solo 401(k) plan if your spouse works with you.

Another aspect to a one-participant 401(k) is that you are the employer. Those employer contributions will be coming from the profits of the business, and are usually tax deductible. You'll also need to consider what your post-retirement income will be. If you expect your income to be lower than it is now, you may want to opt for the traditional plan. You'll get the tax advantages now and save during retirement by being in a lower tax bracket. The opposite is true if you expect your income to be higher at retirement -- it may make sense to defer the tax benefits and choose the Roth option now.  In either case, the employer contributions are pre-tax.

To open a one-participant 401(k) you'll need an EIN. If you have over $250,000 in your 401(k), you're required to file Form 5500-EZ with the IRS.

To open an individual 401(k), you'll need to get a written 401(k) plan, open the account and make the employee part of your contribution on or before December 31. You have until the tax filing deadline to make the employer contribution. You may contribute up to $19,500 as of 2020 with an additional 25% of your net self-employment income as employer contributions. Mandatory withdrawals begin at age 72 and there are penalties for withdrawals made before age 59 1/2.

Simplified Employee Pension (SEP) IRA

The second retirement plan for the self-employed is the SEP IRA. SEP IRAs are employer-sponsored retirement plans with higher contribution limits than traditional IRAs. This makes them a good choice if you have a few employees and want to provide them with a way to save for retirement.

The key features of a SEP IRA are:

  • SEP IRAs are an option for sole proprietorships, partnerships, and corporations.
  • You may exclude some employees, including union members who have negotiated retirement benefits.
  • The money you contribute can be managed by employees and invested as they wish.
  • Employees may not contribute; it is only employer contributions.

You may contribute up to 25% of each employee's compensation (including your own) every year. You also have the option of adjusting contributions year-to-year based on what you can afford. The withdrawal rules are the same as for traditional IRAs, meaning there are penalties for withdrawing money before age 59 1/2 and withdrawals are mandatory starting at age 72.

Savings Incentive Match Plan for Employees (SIMPLE) IRA

The SIMPLE IRA is a good option if you have 100 or fewer employees and would like to offer a retirement plan where both you and the employee may contribute. It operates very much like a traditional IRA with contribution limits and withdrawal requirements.

The benefits of a SIMPLE IRA are:

  • As the employer, you may contribute 2% of each employee's salary as a non-elective contribution or up to 3% in employer matching funds.
  • SIMPLE IRAs are easy to set up, with minimal paperwork and reporting requirements.
  • Employers get a tax deduction for contributions they make on behalf of employees.
  • As with SEP IRAs, you have the option to exclude employees with union-negotiated retirement benefits.

SIMPLE IRAs apply only to self-employed people with less than 100 employees. Taxes must be paid when funds are withdrawn since contributions are made pre-tax. There are tax penalties for withdrawals made before age 59 1/2, and withdrawals are mandatory at age 72.

The SIMPLE IRA may be the best retirement plan for self-employed people with multiple employees. A SIMPLE IRA can be established using IRS Form 5304-SIMPLE to allow employees to choose their financial institution or 5305-SIMPLE if you want to choose the financial institution. Employees must complete a SIMPLE IRA Adoption Agreement to open their accounts.

Traditional IRA

One of the most popular options is the Traditional Individual Retirement Account or IRA.

Traditional IRAs offer tax-exempt contributions that can allow you to contribute up to $6,000 per year with an additional $1,000 in catch-up contributions if you are over 50. Contributions are tax-exempt, so there are tax penalties for early withdrawals (before age 59 1/2) and you'll be required to pay taxes when funds are withdrawn.

An IRA may not be the best option for high earners, if they are eligible for retirement plans at work. People making $65,000 per year or less ($104,000 or less if married filing jointly) may make the full contribution. Partial contributions are allowed for people making more than $65,000 but less than $75,000 per year (more than $105,000 but less than $125,000 for married filing jointly) and people making more than $75,000 and $125,000 respectively are ineligible.

The benefit of a traditional IRA is that it allows you to save money on your taxes now and make catch-up contributions. In addition to contributing far less than you can with some of the other plans listed here.

Roth IRA

Like Roth 401(k) plans, Roth IRA plans are funded with post-tax dollars. While that may somewhat reduce the amount that you can afford to contribute, there are significant post-retirement tax advantages to consider as you evaluate retirement plan options.

The contribution limits for Roth IRAs are the same as for traditional IRAs. The biggest benefit of choosing a Roth IRA is that you do not need to make mandatory withdrawals starting at age 72, so you can allow your investments to grow if you're still working or don't need to supplement your income.

Opening either a traditional or Roth IRA is easy and can be done online in just a few minutes. All you need is an online account where you can get funds.

Which Retirement Plan is Best for Me?

Here are a few questions to ask yourself when choosing a retirement plan.

  1. Do I expect my post-retirement income to be higher or lower than my current income?
  2. Do I need a way to reduce my tax burden now?
  3. Am I behind on retirement savings?
  4. Do I have employees?
  5. If I do have employees, do I want to fund a retirement plan for them?

You may also want to read: Savers Tax Credit: Obscure Tax Deduction You May Not Know About

At Cook Martin Poulson, we are happy to help you navigate and can walk you through the specifics of the various plans and the benefits as they relate to your work, life, and income. Cook Martin Poulson works with individuals and business owners to set up and administer retirement plans.

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