There’s a growing number of people in America taking charge of their careers and becoming self-employed professionals. In fact, a recent Gallup poll for Intuit found that nearly 30% of Americans are now self-employed, with 14% reporting self-employment that provides their primary income.
Of course, this shouldn’t be too surprising. Over the last 20 years, online accessibility has gone from simple intra-nets used by only the largest corporations and colleges, to the global network of ever-connected-cellphones we carry with us everywhere we go. This has made it easier than ever for corporate workers to branch out into self-employment. From consultants to freelance workers, these self-employed professionals are finding that working from home fits their lifestyle.
And it isn’t just corporate workers who are making a go of it on their own. Members of the laboring workforce may leave their jobs to open their own businesses once they’ve gained the high-level skills from their respective trades. Plus, independent makers and craftspeople make up a substantial amount of the self-employed workforce. In fact, 43% of newly self-employed workers say they made the decision to go out on their own to make a career change.1
So, with a growing self-employed workforce, there are a lot more questions about handling the basics. And when it comes to retirement—something that companies usually set up for their employees—the self-employed are wondering the best way to plan for their future.
Luckily there are retirement account options for those of us who work for ourselves—and some have some nice perks of their own.
Setting Up a Traditional IRA When Self-Employed
An IRA is a tax-advantaged retirement investment account. While companies often provide a 401(k) plan for retirement investing, anyone can set up an IRA.
With a Traditional IRA, contributions are often tax-deductible, and any earnings can potentially grow tax-deferred until you withdraw in retirement. Since you aren’t paying those taxes on the interest until you withdraw, the earnings have the potential to grow faster. This account may be for you if you think you could be paying a lower tax rate in retirement than you did while you were earning. The maximum annual contribution in 2020 is $6,000 (or $7,000 if you are 50 or older).2
You can also set up a Roth IRA, which is similar, but it isn’t tax deductible—you pay taxes upfront, instead of when you withdraw them in retirement. Your money may still grow tax-free. And if you anticipate having a higher tax rate when you retire, this account may be right for you. The maximum annual contribution for a Roth IRA may depend on your income.
Keep in mind that you can have both a Traditional IRA and a Roth IRA at the same time to maximize contributions.
Creating a Solo 401(k) or “One-Participant 401(k)”
If you’re self-employed and don’t have any employees, you can open a One-Participant 401(k). The contribution limits on this account are much higher than a traditional IRA. The total limit could be as high as $57,000 in 2020, with a $6,000 catch-up contribution for those 50 or older.
How are the limits this much higher? Well, think of it this way: you are both the employer, and the employee. This means you can choose to match your own contribution limits. A standard employer-offered 401(k) lets you contribute $19,500 annually, and many employers choose to “match” a certain percentage as a perk for working at their company—often around 5%. But since you are your employer, you could match up to 25% of your contribution to this plan.
There’s also a special rule that allows you to contribute 25% of net self-employment income, which is your net profit, minus half of your self-employment tax and the plan contributions you made.
You can even hire your spouse—they’ll be exempt from the “no employees” rule—potentially doubling your contributions.
It has the same tax advantages as a Traditional IRA, and you can even open a Solo Roth account. And although it may sound more complicated than one of those options, most online brokers can help you open a Solo 401(k) and explain how it could work with your specific situation.
Using a SEP IRA Plan In Your Small Business
So a Solo 401(k) plan may be great if you don’t have any employees. But what if you do? Well the SEP-IRA is a similar plan, and great for those who are self-employed, but with employees of their own.
With this plan, your contribution limits are the same (except with a $285,000 limit on the income that can be used to determine that contribution). But there is one very important detail for those with employees: you must contribute the same match to your employee as you do yourself. That means if you use the full 25% match, you have to also provide that match potential for your employees.
SEP IRA plans don’t require annual reporting to the IRS, but you will need to think about the cost to your business as you add employees.
Learn More About Keogh Plans
The term Keogh Plan isn’t used much anymore. It used to be the name for a retirement plan for self-employed people, and it was named after a law that allowed unincorporated businesses to sponsor retirement plans. These days the government doesn’t differentiate between incorportated businesses and self-employment plans, so the term is less common.
The IRS calls these plans “qualified plans” and they can include defined contribution plans like profit-sharing plans or money purchase plans. These plans can invest in stocks, bonds, CDs, and annuities—just like 401(k)s and IRAs. Qualified plans can also include “defined benefit plans” which are like a traditional pension plan with a stated annual benefit based on salary and years of service.
So which plan is right for you?
There are a lot of retirement options for the growing number of people who are self-employed. And while some are more simple, some offer tons of potential for maximizing tax benefits and saving possibilities. Some could be better for sole proprietors, while some may be more fit to the owner of a small business with a few employees.
Here, you’ve been able to get some basics—but the best option is always to talk to a financial representative! They can help you understand your options, formulate a smart plan for your retirement, and your specific situation.
1Freshbooks. “Second Annual Self-Employment Report,” Page 2. Accessed Aug 23, 2020.
2IRS.gov. “IRA FAQS – Contributions” Accessed Aug 23 2020 https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras-contributions#:~:text=The%20annual%20contribution%20limit%20for,your%20filing%20status%20and%20income.
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