6 Retirement Plans for the Self-Employed: How to Save Smartly

Retirement plans for self-employed individuals can include the usual programs like IRAs and 401(k)s and the less common defined benefit plan or HSA. Regardless of your choice, setting up a retirement plan early on is crucial, even for self-employed individuals, to ensure that you can still fully enjoy life post-retirement.

Fortunately, there are different retirement plans for self-employed individuals at various life stages and financial standings. In today’s article, we’ll discuss the best plans you can invest in and offer some tips to help you choose the right one.

Let’s start!

Key Takeaways

• Planning for retirement as a self-employed individual is crucial to ensure that you can maintain your current comfort and lifestyle even if you are no longer eligible to work.
• The best retirement plans for self-employed individuals include Solo 401(k), SEP IRA, Simple IRA, defined-benefit, HSA, and profit-sharing plans.
• To help you choose the right retirement plan for you, it’s important to evaluate your income level, tax situation, and retirement goals.
• Tax benefits of retirement plans for the self-employed include tax-deductible contributions and tax-free distributions.
• When planning for retirement as a self-employed individual, remember to consider your current financial status, start early, and invest in multiple plans.

Why is it Important to Plan for Retirement as a Self-Employed Individual?

It’s important to plan for retirement as a self-employed individual, as it ensures financial security in your later years. Earning a sizable income and taking on multiple jobs to finance your lifestyle is easily doable while you are young, but this does not guarantee that you will have the same opportunities later on.

Previously called Keogh plans, retirement plans for self-employed people allow you to enjoy great tax savings, such as those from Individual Retirement Accounts (IRAs) or Solo 401(k)s, that can help reduce your taxable income.

Moreover, unlike traditional employees, self-employed individuals don’t have the benefit of a regular monthly salary, and having a retirement plan can help tide you over in case you run into financial hardship or unexpected medical expenses.

6 Best Retirement Plans for the Self-Employed

From Solo 401(k)s to HSAs, there are several retirement plans for self-employed individuals that offer varying levels of tax benefits, advantages, and disadvantages.

Let’s discuss each one in detail:

#1. Solo 401(k)

A solo 401(k) plan, also called the “one-participant 401(k)“, is a type of retirement plan for self-employed individuals or business owners without any employees.

Solo 401(k) plans are one of the more flexible independent contractor retirement options since they allow you to contribute as both an employee and employer. For employee contributions, you are limited to $23,000 in 2024 for ages 50 and above. Meanwhile, for employer contributions, you are limited to 25% of your total self-employment income.

This allows you to save more money compared to other retirement plans for the self-employed.

#2. SEP IRA

Since a solo 401(k) for small business owners isn’t always possible due to employee limitations, a SEP IRA plan (or a Simplified Employee Pension IRA) may be more suitable if you have several employees on the payroll.

SEP IRA plans are arguably the best retirement accounts for entrepreneurs who handle a small team of employees and want to provide a retirement plan for them as well. The contribution limit for this retirement plan in 2024 is set at 25% of your total net earnings, up to a maximum of $69,000.

Like 401(k)s, one of the tax benefits of a SEP IRA is a reduction in your taxable income, so regardless of how you pay yourself as a business owner, this plan can help increase your take-home pay.

#3. SIMPLE IRA

While SEP IRAs are a great retirement plan for self-employed individuals with a small employee roster, a SIMPLE IRA is best for businesses with up to 100 employees. A SIMPLE IRA (or the Savings Incentive Match Plan for Employees IRA) offers similar benefits to a SEP IRA but requires an annual contribution.

This retirement plan has a limit of $16,000 in 2024 and allows employers to match their employees’ contributions dollar-for-dollar or provide a fixed 2% contribution regardless of whether the employee contributed or not.

#4. IRA

Individual Retirement Accounts (IRAs) are generally regarded as the best retirement plan for self-employed people and regular employees alike. These are split into two basic types—traditional and Roth.

Traditional IRAs have no income limits and allow tax-free contributions on your state and federal income tax returns until you make a withdrawal. With Roth IRAs, on the other hand, contributions are taxed, but withdrawals made during retirement are not.

That said, if you’re planning to choose an IRA for your self-retirement plan, keep in mind that you won’t be eligible for it if you are single and earn over $161,000 or married and earn over $240,000.

#5. Defined Benefit Plan

Defined benefit plans are a type of self-employed pension plan that offers great return potential for high-income individuals or those working in large corporations or the government. For the latter, the retirement benefit will be calculated based on their salary and tenure in the company.

Because there are no contribution limits with this type of retirement plan, self-employed individuals can save more for their retirement. If you run a business, you can also offer this plan to your employees by making contributions on their behalf.

6. HSA

A Health Savings Account (HSA) is a unique plan that allows you to withdraw funds early with no penalties or taxes to cover qualified medical expenses. While not strictly a self-employed retirement account, HSA contributions can still be used for retirement as long as you don’t withdraw them early and allow them to grow tax-deferred in the account.

How to Choose the Right Retirement Plan if You’re Self-Employed

To choose the right retirement plan for self-employed individuals, you need to carefully evaluate your current financial situation and your future retirement goals. For instance, if you are a freelancer or independent contractor with fluctuating income, a flexible plan like a Solo 401(k) or IRA may be the most suitable option since they don’t require fixed contributions.

On the other hand, if you consistently have a high income as an entrepreneur or business owner, then it may be best to set up a defined benefit plan that will help you get the most out of your retirement plan.

Aside from your income, you should also consider your tax situation, as some retirement plans for self-employed individuals offer tax-deductible contributions that can reduce your taxable income.

Finally, you’ll need to assess how much you can contribute every year and how that aligns with your retirement goals. If you want to live comfortably, then it only makes sense to save more aggressively. However, if you aren’t able to consistently keep up with the contributions, you may need to rethink your goals and choose a different retirement plan.

Tax Benefits of Self-Employed Retirement Plans

Some retirement plans for self-employed individuals offer tax benefits that can help reduce your tax liabilities.

Let’s discuss each plan’s tax benefits below:

• Solo 401(k). With this plan, contributions aren’t taxed, but retirement distributions made from age 60 and above will be taxed.

• SEP IRA. In a SEP IRA, a portion of the retirement contributions, or 25% of your earnings, can be deducted from your tax return. However, withdrawals will be taxed as income.

• SIMPLE IRA. In this plan, contributions are tax-deductible, while distributions are taxed.

• Defined benefit plan. Similar to SIMPLE IRAs, defined benefit plans have tax-deductible contributions and taxed distributions.

• HSA. Withdrawals from your HSA that are not for medical expenses are taxed.

3 Best Practices for Retirement Planning as Self-Employed

Now that you know the best retirement plans for self-employed individuals, here are three best practices to keep in mind to help you maximize their benefits:

#1. Consider Your Current Financial Situation

One of the most important things to remember when setting up retirement plans for self-employed individuals is to consider your financial situation. Some plans may yield higher benefits come retirement but are more expensive to maintain and may not be feasible for your current income.

To accurately assess your financial capability, you need to track your income and expenses on a self-employment ledger. One way to streamline this process is to use an invoice or paystub generator like Paystub.org when creating client paystubs and invoices.

Our tool provides you with standardized templates that make it easier to monitor your cash flow and gain a comprehensive overview of your financial standing. When you know how much you can spare for your retirement, you’ll be able to limit your options and find the best plan for you.

#2. Invest in Multiple Retirement Plans

Another great retirement savings tip for freelancers and self-employed individuals is to invest in multiple plans to achieve a more reliable safety net.

For instance, you can diversify your retirement portfolio by setting up a Solo 401(k) and an HSA, so the former can be used for your day-to-day needs while the latter is specifically for medical expenses.

Alternatively, you can invest in a defined benefit plan during your high-earning years and then switch to a tax-free retirement plan like a Roth IRA during business downtime to maximize your contributions.

#3. Start Planning For Your Retirement Early

Lastly, it’s best to start planning early and set up a retirement plan as soon as you have a steady gig. The earlier you select and invest in a pension scheme for self-employed individuals, the greater your interest earnings will be. Don’t worry about the amount of contributions first, as consistency is more important.

Final Thoughts

The right retirement plans for self-employed individuals ensure that they can enjoy financial security and long-term stability even after retiring. If you want to start planning for retirement, it’s important to start with proper financial management to gauge your current status and capabilities.

One way to do this is by using Paystub.org’s paystub generator to simplify how you track your earnings and tax deductions so you can set realistic retirement goals and choose the best plan for your needs.

Retirement Plans for Self-Employed FAQ

#1. What is the best retirement plan for self-employed individuals?

The best retirement plan for self-employed individuals is the one that meets your needs and financial capabilities. For instance, if you have a high income and want to save significantly for retirement, then a defined benefit plan may be best for you. On the other hand, if you want to set up a retirement plan for you and your employees, you should consider a SEP IRA plan.

#2. Can self-employed individuals contribute to a 401(k)?

Yes, self-employed individuals can contribute to a 401(k), but only if they don’t have any other employees aside from themselves. In fact, according to the IRS, you can contribute an additional 25% of your net earnings as an employer to your 401(k) plan.

#3. Are retirement contributions tax-deductible for self-employed individuals?

Yes, retirement contributions can be tax-deductible for self-employed individuals. These are then deducted from your Form 1040, Schedule 1, and depend on your plan type and the limits the IRS sets.

#4. What’s the difference between a Roth IRA and a traditional IRA?

The difference between a Roth IRA and a traditional IRA is in their tax benefits; contributions to Roth IRAs are taxed, while traditional IRA contributions are not. However, withdrawals for traditional IRA plans are taxed, and Roth IRAs are not.

#5. Which is better, SEP IRA or solo 401(k)?

The solo 401(k) plan is usually better for self-employed individuals with no other employees, as it offers more flexibility and a higher contribution limit. However, if you own and operate a small business, then you won’t qualify for a solo 401(k) plan and would have to set up a SEP IRA for you and your employees.