Retirement Plan Options for the Self-Employed
There are five main choices for the self-employed or
small-business owners: an IRA (traditional or Roth), a Solo 401(k), a SEP IRA, a SIMPLE IRA or a defined
Being self-employed gives you a certain measure of freedom, but it doesn’t give you an excuse to skip
out on saving for retirement.
In fact, it makes putting money away that much more crucial: Unlike an employee who might have access
to a 401(k), you’re on your own.
The first step: Figure out how much you need to save for retirement. The amount
you plan to save each year will help determine the best account for you.
Second: Decide where to put that money. The good news is that flying solo gives you a lot of options.
1. Traditional or Roth IRA
Best for: Those just starting out, or saving less than $6,000 a year. If you’re
leaving a job to start a business, you can also roll your old 401(k) into an IRA.
limit: Up to $6,000 in 2019 ($5,500 for the 2018 tax year), plus a $1,000 catch-up
contribution for those 50 or older.
Tax advantage: Tax deduction on contributions to a traditional IRA; no immediate
deduction for Roth IRA, but withdrawals in retirement are tax-free.
Employee element: None. These are individual plans. If you have employees, they can
set up and contribute to their own IRAs.
An IRA is probably the easiest way for self-employed people to start saving for retirement. There are
no special filing requirements, and you can use it whether or not you have employees.
An IRA is probably the easiest way for self-employed people to save for
The toughest part might be deciding which type of IRA to open: We’ve given in-depth coverage to the
differences between traditional and Roth IRAs
, but the tax treatment of a Roth IRA might be ideal if it’s early days for
your business (read: you’re not making much money). In that case, your tax rate is likely to be higher
in retirement, when you’ll be able to pull that money out tax free.
One note: The Roth IRA has income limits for eligibility; those who earn too much can’t contribute.
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2. Solo 401(k)
Best for: A business owner or self-employed person with no employees (except a spouse,
Contribution limit: Up to $56,000 in 2019 (plus $6,000 catch-up contribution for those
50 or older) or 100% of earned income, whichever is less. To help understand the contribution limits
here, it helps to pretend you’re two people: An employer (of yourself) and an employee (also of
In your capacity as the employee, you can contribute as you would to a standard employer-offered
401(k), with salary deferrals of up to 100% of your compensation or $19,000 (plus that $6,000 catch-up
contribution, if eligible), whichever is less
In your capacity as the employer, you can make an additional contribution of up to 25% of
There is a special rule for sole proprietors and single-member LLCs: You can contribute 25% of net
self-employment income, which is your net profit less half your self-employment tax and the plan
contributions you made for yourself
- The limit on compensation that can be used to factor your contribution is $280,000 in 2019
Tax advantage: This plan works just like a standard, employer-offered 401(k): You make
contributions pre-tax, and distributions after age 59½ are taxed
Employee element: You can’t contribute to a solo 401(k) if you have employees. But you
can hire your spouse so he or she can also contribute to the plan. Your spouse can contribute up to the
standard employee 401(k) contribution limit, plus you can add in the employer contributions, for up to an additional
$56,000 total, plus catch-up contribution, if eligible. This potentially doubles what you can save as a
2019 401(k) contribution limit
|Under 50 ||
|50 or older||
How to get started: You can open a solo 401(k) at many online brokers. You’ll
need to file paperwork with the IRS each year once you have more than $250,000 in your account.
This plan, which the IRS calls a “one-participant 401(k),” is particularly attractive for those who can
and want to save a great deal of money for retirement or those who want to save a lot in some years —
say, when business is flush — and less in others.
A solo 401(k) is attractive for those who can and want to save a great
deal of money in some years.
Keep in mind that the contribution limits apply per person, not per plan — so if you also have outside
employment that offers a 401(k), or your spouse does, the contribution limits cover both plans.
One other thing to know: You can also choose a solo
, which mimics the tax treatment of a Roth IRA. Again, you might go with this option if your income and tax rate are lower now
than you expect them to be in retirement.
» Learn more about the
3. SEP IRA
Best for: Self-employed people or small-business owners with no or few employees.
Contribution limit: The lesser of $56,000 in 2019 ($55,000 in 2018) or up to 25% of
compensation or net self-employment earnings, with a $280,000 limit on compensation that can be used to
factor the contribution. Again, net self-employment income is net profit less half of your
self-employment taxes paid and your SEP contribution. No catch-up contribution.
Tax advantage: You can deduct the lesser of your contributions or 25% of net
self-employment earnings or compensation — limited to that $280,000 cap per employee in 2019 (up
from $275,000 in 2018) — on your tax return. Distributions in retirement are taxed as income. There
is no Roth version of a SEP IRA.
Employee element: Employers must contribute an equal percentage of salary for each
eligible employee, and you are counted as an employee. That means if you contribute 10% of your
compensation for yourself, you must contribute 10% of each eligible employee’s compensation.
Get started: You can open a SEP IRA at many online brokers just as you would a
traditional or Roth IRA, with a few extra pieces of paperwork.
A SEP IRA is easier than a solo 401(k) to maintain — there’s a low administrative burden with limited
paperwork and no annual reporting to the IRS — and has similarly high contribution limits. Like the
solo 401(k), SEP IRAs are flexible in that you do not have to contribute every year.
SEP IRAs have a low administrative burden, and they require limited
paperwork and no annual reporting to the IRS.
The downside for you, as the business owner, is that you have to make contributions for employees, and
they must be equal — not in dollar amount, but as a percentage of pay — to the ones you make for
yourself. That can be costly if you have more than a few employees or if you’d like to put away a great
deal for your own retirement. You cannot simply use a SEP to save for yourself; if you contribute for
the year, you have to make contributions for all eligible employees.
4. SIMPLE IRA
Best for: Larger businesses, with up to 100 employees.
Contribution limit: Up to $13,000 in 2019 or $12,500 for 2018 (plus catch-up
contribution of $3,000 if 50 or older). If you also contribute to an employer plan, the total of all
contributions can’t exceed $19,000 (or $18,000 for the 2018 tax year).
Tax advantage: Contributions are deductible, but distributions in retirement are
taxed. Contributions made to employee accounts are deductible as a business expense.
Employee element: Unlike the SEP IRA, the contribution burden isn’t solely on you:
Employees can contribute through salary deferral. But employers are generally required to make either
matching contributions to employee accounts of up to 3% of employee compensation, or fixed contributions
of 2% to every eligible employee. Choosing the latter means the employee does not have to contribute to
earn your contribution. The compensation limit for factoring contributions is $280,000 in 2019 ($275,000
Get started: The process is similar to a SEP IRA — you can open a SIMPLE at an
online broker, with a heavier paperwork load than your standard IRA.
If you’re the owner of a midsize company with fewer than 100 employees, the SIMPLE is a fairly good
option, as it’s easy to set up and the accounts are owned by the employees.
SIMPLE IRAs can be expensive if you have a large number of employees who
SIMPLE IRA contribution limits are significantly lower than a SEP IRA or solo 401(k), however, and you
may end up having to make mandatory contributions to employee accounts, which can be expensive if you
have a large number of employees who participate.
| ||SIMPLE IRA||401(k)|
|Employer eligibility||Employers with 100 or fewer employees||Any employer with one or more employees|
All employees who have compensation of at|
least $5,000 in any prior 2 years, and are reasonably expected to earn at least $5,000 in the current year
|All employees at least 21 years old who worked at least 1,000 hours in a previous year|
|Employer contribution rules|
- Mandatory employer contribution: Either matching contribution of up to 3% of employee's pay or contribution equal to 2% of employee’s compensation, even if employee does not contribute.
- All contributions vest immediately.
- Employer contributions deductible on business tax return.
- Employer contributions are optional.
- Employee contributions vest immediately. Employer sets vesting schedule for employer contributions.
- Required proportional contributions for each eligible employee if you contribute for yourself.
- Employer contributions deductible up to IRS limits.
- Employee contribution limit: $13,000; $16,000 for those age 50 or older.
- No limit on employer matching contribution; if using the 2% contribution based on compensation, employer match allowed on up to $280,000 of salary.
- Employee contribution limit: $19,000; $25,000 for those age 50 or older.
- Combined contributions of employee and employer are limited to the lesser of 100% of compensation or $56,000 ($62,000 if age 50 or older).
|Administrative responsibilities||No annual tax filing requirements; annual plan details must be sent to employees||Subject to annual compliance testing to ensure plan does not favor highly compensated employees|
|Fees||Minimal account fees||Varies by plan|
|Investment options||Any investments available through the financial institution that holds accounts||Investment selection curated by employer and plan administrator|
- Requires minimal administrative management.
- Lower setup and maintenance costs.
- Participants may be allowed to choose account provider.
- Higher contribution limits.
- Roth 401(k) option available.
- Employer contribution is optional.
- Vesting schedule set by employer.
- Plan may permit loans.
- Mandatory employer contribution.
- No Roth option.
- Lower contribution limits.
- 25% penalty on distributions made before age 59½ and within the first two years of participation in the plan.
- No loans allowed.
- Employer cannot maintain any other type of retirement plan.
- Higher setup costs and administrative requirements.
- Plan fees can be high, especially for small businesses.
The SIMPLE IRA is also inflexible, particularly early on: Early withdrawals, before age 59½, are
treated the same as early 401(k) or IRA distributions, in that they are taxed as income and subject to
10% penalty. But if you make a withdrawal within the first two years of participation in a SIMPLE IRA,
the 10% penalty is increased to 25%. That means you also can’t roll over a SIMPLE to another retirement
account within that two-year period. Zing.
One other thing to know: There is a 401(k) version of a SIMPLE, which works in much the same way but
allows participants to take loans from their accounts. This version requires more administrative
oversight and can be more expensive to set up.
5. Defined Benefit Plan
Best for: A self-employed person with no employees who has a high income and wants to
save a lot for retirement on an ongoing basis.
Contribution limit: Calculated based on the benefit you’ll receive at retirement, your
age and expected investment returns.
Tax advantage: Contributions are generally tax deductible, and distributions in
retirement are taxed as income. An actuary must figure your deduction limit, which adds an
Employee benefit: If you have employees, you generally offer this plan to them and
make contributions on their behalf.
We often lament the decline of pension plans, and this is exactly that: If you’re self-employed, you
can set up your own pension — a guaranteed stream of income — in retirement by using a defined benefit
So why wouldn’t everyone do it? They’re expensive, with high setup and annual fees. If you have
employees, that fee will likely go up, and you’ll need to contribute on their behalf. They carry a heavy
administrative burden each year, and they require a commitment to fund the plan with a certain amount
per year. If you need to change that amount, you’ll pay additional fees.
The upside is that you can stash a lot of cash in these, so if you’re fairly close to retirement,
earning a high income that you know you’ll maintain and that allows you to save a significant amount per
year — we’re talking $50,000 to $80,000 or more — you might consider using this plan to supercharge your