The 6 Best Retirement Plans for Self-Employed People

Being self-employed is great, right? So much freedom and flexibility. But what about your future? You don’t have the same benefits as an employee. You have to take care of insurance on your own, pay self-employed taxes, and save for retirement without the help of an employer match. So how do you save up for the eventual day you stop working? Well, you’re in luck because we found the best retirement plans for the self-employed.

The Stats

There are 57 million freelancers in the U.S., according to a 2017 study by Edelman Intelligence, and the number is only growing. As of 2017, nearly a third of the American workforce did some type of freelance work, a drastic change from the 9 percent reported in 2005 when the data was first collected by the Bureau of Labor Statistics. I’m proud to count myself among them.

Freelance and contract positions are likely the way of the future as companies look for cheaper ways to hire workers. When companies hire freelancers, they don’t need to pay taxes or benefits on your behalf, making freelancers an attractive option to many.

Consequently, that means that freelancers are responsible for their own retirement savings. And with the possibility of Medicare becoming insolvent by 2026, and Social Security by 2037, it’s more important than ever to take charge of your own financial future. But don’t fret: There are a handful of financially savvy options available to the self-employed.

Since we’re self-employed, we don’t have a company retirement plan set up for us. So how do we save for our future?

There aren’t any retirement plans that are designed specifically for freelancers. However, there are certain plans that work particularly well with the nature of their work. (Though, of course, whether you’re a freelancer or a W-2 employee, the best practice for everyone is to start saving early and be consistent.) Here are six of the best retirement plans that we found for self-employed workers.

1. SEP IRA

A simplified employee pension (SEP) is a plan that allows employers to contribute to retirement, both for themselves and for their employees. These plans are available to all businesses, but they’re most popular with self-employed people because of their low start-up costs and high contribution rates. SEP contributions can be up to 25 percent of the employee’s compensation or $56,000 for 2019, whichever is less.

To open an SEP plan, fill out Form 5305-SEP. The form can be found on the IRS website. After creating an SEP for yourself, you can then create your own  Individual Retirement Plan (known in this context as an SEP IRA). Keep in mind that if you use this method, you can’t have another retirement that isn’t also an SEP. That said, you can roll over most previous accounts into an SEP.

There’s no filing requirement for the employer in an SEP plan. And only the employer may make contributions. Employees aren’t allowed to. The employees own everything in their accounts — they just can’t contribute to it like they can to a 401(k) or a Roth IRA. Employees also get to decide where exactly to invest their money, giving them control over their portfolio.

Contribution amounts are flexible and can vary from year to year.

This allows you to modify your contributions according to how well your business is growing.

That makes an SEP IRA is an attractive option for business owners. But contributions do need to be the same rate for all employees. For instance, if one employee gets 5 percent, so does everyone else.

2. Solo 401(k)

A solo 401(k) plan functions the same way as a traditional company 401(k). The only difference is that this plan covers either a business owner with no employees or that person and his or her spouse. In other words, it’s designed for self-employed folks.

Solo 401(k)s are subject to the same rules and requirements as any other 401(k) plan. The business owner is defined as both the employer and the employee in this plan. This means that you can make contributions to the plan in both roles. According to the IRS, the owner can make two kinds of contributions:

• Elective deferrals of as much as 100 percent of compensation (“earned income” in the case of a self-employed individual). You make these as the employee and can contribute up to the annual limit ($19,000 in 2019, or $25,000 if age 50 or over).
• Nonelective contributions. You make these as the employer, and they’re not deducted from your salary as the employee. These can be up to 25 percent of compensation, though it can vary if you’re self-employed.

Figuring out how much you can contribute does take a bit of math. The IRS provides worksheets for people to figure out their contribution rates and what their tax deductions will be. It’s a good idea to hire an accountant or CPA to make sure you’re adding as much as you legally can and that it’s also in line with what you can afford.

3. Roth IRA

Roth IRAs aren’t specifically for freelancers, but they’re an excellent retirement vehicle that you can take advantage of. A Roth IRA is an Individual Retirement Account option that’s available to anyone.

Roth IRAs are set up so that upon retirement, the money withdrawn from the account is tax-free.

As such, your contributions to a Roth IRA are not tax-deductible, meaning you pay tax upfront on the amount you put into the account, but not upon withdrawal. Additionally, you can contribute to a Roth IRA only if you make under a certain amount. You’re capped at $122,000 if filing as a single person, or $193,000 for married couples.

The maximum amount you can contribute annually to a Roth IRA is $6,000 for people under 50. For those 50 and up, it’s $7,000. This is designed to give a boost to those who got a late start in saving.

4. Traditional IRA

Alternatively, a traditional IRA functions inversely to a Roth IRA. While a Roth IRA requires contributions be taxed before being put into an account — with the incentive being that withdrawals are not taxed — contributions to a traditional IRA are tax-deductible upon deposit, and the withdrawals are taxed.

In short, Roth IRAs and traditional IRAs both function as similar retirement vehicles. The primary difference is whether your contributions are subject to taxes beforehand (Roth) or afterward (traditional).

5. SIMPLE IRA

A savings incentive match plan for employees, known simply as a SIMPLE IRA Plan, is similar to an SEP IRA in its ease of setup. Just like an SEP, a SIMPLE IRA plan requires that you fill out a Form 5305 or 5304 SIMPLE to establish the plan, followed by establishing a SIMPLE IRA at a bank or financial institution.

When creating a SIMPLE IRA, the self-employed individual acts as both the employee and the employer.

As the employee, you can contribute up to $13,000 for 2019, plus an extra $3,000 if you’re over 50. As the employer, you’re required to either contribute 2 percent of your yearly net income or match your own contribution up to 3 percent.

So for example, if you earned $40,000 a year and chose to contribute 5 percent of your income as the employee ($2,000), you’d have to contribute an additional 3 percent ($1,200) as the employer, making your total contribution $3,200.

The mandated employer contributions of a SIMPLE IRA can make it a difficult plan to manage as a sole proprietor. However, like a traditional IRA, you won’t pay taxes on your contributions until you begin to make withdrawals from your account. That said, if you choose to withdraw from a SIMPLE IRA within two years of filling out your Form 5305/5304, you’ll incur a hefty 25 percent tax on your contributions. Ouch. Proceed with caution if you’re considering this retirement plan as a self-employed worker.

6. Defined Benefit Plan

Defined benefit plans closely resemble a traditional employee pension in the sense that they have a stated annual benefit — meaning you know specifically how much money you’ll have per year upon retiring. This makes your retirement plan function essentially as if you were still receiving a set yearly income.

You define how much you want to receive as a yearly benefit and then create a schedule of contributions to make sure you meet that total. In this way, defined benefit plans offer a ton of freedom in creating a timetable for retirement. This can be great for those who started saving late.

These plans have some great benefits, including high contribution rates of up to $225,000 for 2019, and taxes are applied upon withdrawals (rather than being taxed before contribution to the account).

You can also have a defined benefit plan in addition to another retirement plan. This makes it great for individuals who switch between freelancing and working at a company full time.

On top of that, if you run your own business and make contributions as the employer, they are considered business expenses and can be deducted from your taxable income as such. A serious win-win for both sides.

Of course, defined benefit plans are not without their pitfalls. They’re more time-intensive and costly than other retirement plans that self-employed workers might use. This includes requiring an actuary to sign off on your schedule of contributions. Additionally, you must meet your yearly contributions to the defined benefit plan, regardless of other financial commitments. Once you’ve created a plan and set an annual contribution, you need to continue putting that amount away.

Buyer Beware

As is the case with most retirement plans, if you withdraw from your plan before reaching the age of 55, the money withdrawn will be subject to a penalty.

If you withdraw from an account that is tax-deferred — such as a traditional IRA, for which you make contributions tax-free initially — that withdrawal is subject to additional income tax. Conversely, if you withdraw from an account in which the contributions have already been taxed, like a Roth IRA, income tax has already been deducted.

Moreover, nearly every retirement account is subject to an additional 10 percent tax penalty if you withdraw contributions before retirement.

The penalty is in place to discourage early distribution and to ensure that money stays in your account until after you leave the workforce.

What Do Experts Say About Retirement Plans for Self-Employed People?

If you’re self-employed and considering which retirement plan is best for you, you may want to think of the effort necessary to each specific plan, as well as the expected financial benefits upon retirement.

IRAs

“Roth IRA and SEP IRA are both very easy to use and don’t have any type of setup costs,” says certified financial planner Samuel Rad. “You simply decide if you want to contribute to either of these plans before filing taxes. They’re flexible, low maintenance, and low headache.”

However, by investing the time, effort, and money into a solo 401(k), you can create a retirement plan that mirrors the security of an employer-sponsored one.

Solo 401(k)

“A solo 401(k) requires you to contract a third-party plan administrator, which costs more,” Rad says. “You also must plan ahead, and all 401(k) contributions have to be made before the end of the calendar year.”

That said, “with a solo 401(k) plan, you can contribute money into the plan as an employee of your own company, and you can match contributions as the employer of said company,” Rad continues. While more complicated, this plan provides the self-employed with more direct control over their financial future than that of an SEP IRA or a Roth IRA.

“Consider simplicity and contribution limits when deciding on a self-employed retirement plan,” says Brandon Renfro, a retirement income certified professional and assistant professor of finance at East Texas Baptist University.

“An IRA or SIMPLE IRA are very easy to set up and are fine choices if you don’t plan on saving more than the limits allow, and are very easy to set up and maintain.”

“The solo 401(k) is a very good choice for people that want to save more than an IRA. You can save $19,000 as an employee, and your business can contribute as the ‘employer’ for a combined total of up to $55,000. That is a lot of savings.”

Key Factors in Choosing the Best Self-Employed Retirement Plan for You

Both Rad and Renfro agree that there are two key components to choosing a retirement plan: ease of use and amount of contributions. If you foresee yourself putting away the maximum amount for retirement, opt for a solo 401(k) or defined benefit plan. Just be prepared to take on some additional paperwork.

Alternatively, if you project your contributions to be on the smaller side annually, set up a Roth IRA, Simplified Employee Pension, or SIMPLE IRA Plan. Their contribution limits are lower, and they’re easier to maintain.

Finally, consider which retirement accounts can roll over into one another if you anticipate changing your plan in the future. If you’re not currently saving the maximum amount, but have a high earning potential, you can begin saving in a traditional IRA or Simplified Employee Pension, and later transfer those funds to a solo 401(k) to accommodate higher year contributions.

Regardless of what plan you use, saving for retirement is especially important when you’re self-employed. We’re in charge of our own financial futures. As such, we need to start saving today, whether it’s $50 a month or $500.

Additional reporting by Kara Perez.