The Solopreneur's Guide to Retirement Funds

By Simone Johnson,
business.com writer
| Updated
Jul 01, 2020
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Find out which retirement savings plans solopreneurs can use and how to get started with them.

  • Self-employed people who don't have employees have several investment options, including a solo 401(k), IRA, SIMPLE IRA and SEP IRA.
  • Small business owners with employees can set up traditional 401(k) plans or SIMPLE or SEP IRAs.
  • You should consult with a financial advisor or CPA who can help you select a plan that will help you meet your retirement goals. 

Being your own boss is rewarding and can even be fun, but figuring out an efficient way to save for retirement can be challenging. The good news is that there are several savings options that self-employed people can take advantage of. 

Even though solopreneurs can't utilize a traditional 401(k), that shouldn't stop them from investing in other retirement plan options. Understanding IRA and solo 401(k) plans can make a world of difference to your retirement and future. When it comes to preparing for your retirement, the key is understanding your options. 

Can a self-employed person save for retirement on their own?

The answer is yes, and there are several different plan types they can use, such as a solo 401(k) or an IRA. But the real question is, are solopreneurs saving for retirement? According to a Betterment study, almost 40% of the 1,000 entrepreneurs surveyed said they feel unprepared to save enough money to support their retirement, and 19% of them admitted they have nothing saved for retirement. 

Saving on your own is possible, but it's not always as easy as participating in an employer-sponsored retirement plan, and a simple savings account isn't going to cut it. If you stow money away into your bank account, you earn extremely low interest rates, which are unlikely to even keep up with inflation. On top of that, the interest you earn from your savings account is taxed as regular income. This means that if you earn $1,000 in interest and are in a 24% tax bracket, $240 of your interest will go to taxes. If you want to earn a higher return on your savings, you need to put your money in an investment vehicle. 

If you're not worried about saving for retirement because, like 78% of the small business owners polled in a CNBC business succession survey, you plan on selling your business to fund your retirement, make sure you have an accurate idea of what your business will actually sell for.

Depending on what your business is worth, this may be a lucrative plan that will generate enough money for you to live off the proceeds. However, if your business isn't valued as high as you think it should be, selling it may not be as profitable as you'd like. Business brokerage firm Bristol Group Inc. reported that just 20% of businesses listed for sale will be purchased and, in most cases, buyers only pay 75% of the seller's asking price. 

Can you have a 401(k) if you are self-employed? 

You may not be able to have a regular 401(k), unless you have employees and decide to sponsor an employee retirement plan, but you can have a solo 401(k). It works a lot like a 401(k) plan, only you are treated as both the employee and employer. 

With a solo 401(k), you can make elective deferrals from your pay of up to $19,500 (as the employee) and then additional contributions (as the employer), for a total contribution of $57,000 in 2020 if you are under 50, or $25,500 if you are over 50, said Nick Strain, senior wealth advisor at Halbert Hargrove. Many brokers offer this plan at little or no fee, depending on the provider. You also have the option to set up a self-employed 401(k) for your spouse if you co-own the company.  

"You can also make a profit-sharing contribution from the business, in which the dollar amount depends on how your business is structured and your pay," Strain told business.com.   

Like traditional 401(k) plans, solo 401(k) plans have both pre and posttax versions. A Roth 401(K) allows you to make contributions after your taxes have been deducted. This means your withdrawals are tax-free upon retirement. On the other hand, pretax 401(k) contributions are made with before-tax dollars, so you will be taxed on the money when you withdraw it. 

How to get started with a 401(k)

Find a 401(k) fund directly through a financial investment firm that offers the type you’re interested in. The investment firm will ask you to designate an administrator for the self-employed 401(k) plan. Depending on the firm's rules, you may not be allowed to act as the administrator, but you could designate your accountant.

According to TD Ameritrade, you will fill out two forms: a 401(k) application and an adoption agreement. Upon approval, the provider gives you a schedule to calculate your annual contributions. Checks are mailed to the investment firm, along with a 401(k) remittance form. You may be able to rollover other investments into your self-employed 401(k). Examples of financial products that may be eligible for transfer include IRAs, 403(b) plans, and 457(b) government plans.  

Do you get a pension if you are self-employed? 

When you think of retirement, you may think of pensions, which are a type of defined-benefit retirement plan. With a pension, your employer pays you a guaranteed monthly amount after you retire – and unlike with 401(k) plans, the value of the account isn't dependent on the performance of your investments. As a self-employed business owner, you do not get a pension. 

Fortunately, in true solopreneur fashion, you can set up a personal defined benefit plan. This allows a high-income business owner to save more than the $57,000 limit on self-employed 401(k) plan contributions, Strain said.  

The personal defined benefit plan can help you save $100,000 to $300,000 a year. The amount is determined by your annual income. Through this plan, contributions decrease your annual taxable income and can save you a lot of money on taxes.  

"Once the (self-employed) business owner grows their retirement assets and they're ready to retire, they can purchase an annuity through an insurance company for all or part of their retirement savings to create a pension and guaranteed monthly amounts to receive for life," Strain said.  

But buyer beware: Before you purchase an annuity, you need to speak with a trusted advisor – someone who isn't selling annuities and will not make a commission on it – to find out if this is a good option for you. Annuities are notoriously problematic, and you'll pay much more in fees compared to other investment vehicles. 

How much can a self-employed person contribute to an IRA?

There are several kinds of IRAs – individual retirement accounts – that you can use as a solopreneur. Traditional and Roth IRAs are the most popular types, as nearly anyone can use them, but there are also SIMPLE IRAs and SEP IRAs that are only available to small business sole proprietors, explained AJ Smith, vice president of financial education at SmartAsset

One benefit of this type of retirement savings account is that you have more time to invest. You can contribute to an IRA for a given year up to April 15 (the tax filing deadline) of the following year. 

What is a traditional IRA?

traditional IRA is a retirement savings account that has tax advantages. It may minimize your tax bill, because when you make a contribution, it reduces your taxable income for the year. Investments are tax-deferred, meaning you invest pretax dollars and nothing is taxed until you withdraw it. You must wait until you're 59.5 years old to make withdrawals. Otherwise, you must pay a 10% distribution penalty, and the money will be taxed as income. One exception to this rule is that you can withdraw up to $10,000 for a home purchase with no penalty. 

You must have taxable income to contribute to a traditional IRA, but there are no longer age restrictions (before Jan. 1, 2020, individuals over the age of 70.5 could not contribute). The contribution limit for 2020 is $6,000. If you're over the age of 50, you can contribute an additional $1,000 for a maximum contribution of $7,000. 

What is a Roth IRA?

Roth IRA allows you to invest with after-tax dollars, meaning you have already paid income taxes on the money you contribute to this account. Since the money has already been taxed, it's allowed to grow tax-free, and you won't have to pay any taxes on eligible withdrawals from your account (though you must wait until you're 59.5 years old and your Roth IRA has been open for at least five years). There are no required minimum deductions (RMDs) for Roth IRAs. 

To be eligible to open and contribute to a Roth IRA in 2020, your modified adjusted gross income must be $124,000 or less if you're a single filer and $196,000 if you're married and filing jointly. 

The maximum contribution for a 2020 Roth IRA is $6,000. If you're over the age of 50, you can make a catch-up contribution of $1,000, for a maximum contribution of $7,000. 

What is a SIMPLE IRA?

SIMPLE stands for "savings incentive match plan for employees." A SIMPLE IRA plan operates a lot like a regular IRA but has a much higher contribution limit. A sole proprietor can set up a SIMPLE IRA for themselves and contribute to it as both the employer and the employee. 

You must have earned at least $5,000 from your company the previous year to be eligible for a SIMPLE IRA. The contribution limit for a 2020 SIMPLE IRA is $13,500. If you're older than 50, you can make a catch-up contribution up to $3,000, for a maximum contribution of up to $16,500. 

What is a SEP IRA ?

A SEP IRA, which stands for "simplified employee pension," is ideal for small business owners because it doesn't require much paperwork or maintenance and allows you to vary the amount you contribute each year. 

Those who are eligible to participate in a SEP IRA plan include sole proprietors and business owners in a partnership or limited liability company like an S corporation or C corporation. In addition, you must be at least 21 years old, have been self-employed for the past three years, and have earned $600 or more in self-employment income. The contribution limit for 2020 is either up to 25% of your salary or up to $57,000 (whichever is less). 

How to get started with an IRA

You need to find a brokerage firm that offers the type of IRA you're interested in setting up. The firm will advise you on the rules about contributions and what accounts you are eligible to roll into the fund. (SIMPLE IRA accounts usually require less paperwork than other types of retirement accounts.) Once you open your IRA account, you'll fund it through initial contributions and any other rollover assets, such as IRA accounts and 401(k) plans.

What is a Keogh plan?

According to the IRS, a Keogh plan is a term that was previously designated to retirement plans for self-employed individuals. The pensions were called Keogh plans because of the federal law that allowed unincorporated businesses to sponsor retirement plans. Keogh plans can be used by both self-employed workers and unincorporated business structures. It's a tax-deferred pension featuring two distinct plan options: defined benefit or defined contribution.

Defined contribution Keogh plans are when contributions are made into the plan on a regular basis until the fund reaches a set maximum amount. With the defined benefit type, the Keogh plan will have a stated amount of benefits received at retirement age. The benefits are normally calculated by the number of years worked and salary amounts. A maximum annual benefit is set for this type of Keogh plan. For both of these plans, withdrawals start after age 59.5 and before the recipient has reached the age of 70.5. Contributions are tax-deductible up to a certain percentage and subject to change year to year, according to current IRS regulations.

How to get started with a Keogh plan

A Keogh plan must be filed before the end of the tax year of when you'd like to receive the deduction. Since Keogh plans require an extensive amount of paperwork, it's recommended that you enlist the help of a CPA. Each year, IRS Form 5500 will need to be filed in order to qualify for the Keogh plan, according to the IRS.

Which retirement plan is specifically designed for self-employed individuals and their employees? 

Business owners with employees have multiple retirement savings options as well, including traditional 401(k) plans, SEP IRAs and SIMPLE IRAs.  

A traditional 401(k) plan is one of the most popular options for businesses with employees because it allows employees to contribute more money, and they can often choose between pretax and Roth contributions.  

Small business owners with employees can also use a SEP IRA. You can open one through an online broker, and it doesn't require annual tax filings with the IRS. You don't have to contribute to employee accounts every year, but if you have multiple participants, you must contribute the same percentage to each of them.  

A SIMPLE IRA can be used by businesses with up to 100 employees and, like a SEP IRA, is easy to maintain, with no annual tax filings. A SIMPLE IRA demands more paperwork than a regular IRA, though, and although contributions are flexible, you must match employee contributions or contribute to employee accounts.  

 

Editor's note: Looking for the right retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs. 

 

What is the best retirement plan for self-employed business owners?

There is no one workplace retirement plan that works for all self-employed people, but there are some traits you should look for in a retirement savings plan. It should have generous contribution limits, no or low setup costs or annual fees, manageable paperwork, and flexibility as to when you fund the account. Talk to a few different financial advisors, and look into multiple saving platforms to give you an idea of what each company offers and what fees they charge.  

You should plan to work with a financial advisor, certified public accountant or another financial professional. Choose someone who doesn't sell plans and won't make a commission on your retirement account so you can get unbiased, expert advice about which plan is right for you and how much you should be saving for retirement based on your goals and business model.

Before you speak to a financial professional, figure out how much self-employment income you expect to have, suggested Jeff Klauenberg, owner of Klauenberg Retirement Solutions. You should also know how much you can afford to save, whether you want to defer taxes or pay them now on the money you plan to save, how many years you have left until retirement, and whether you'll hire employees (if you don't already have some). 

If you have employees, you should ask yourself if you want to set up a traditional retirement plan that allows you and your employees to make contributions through payroll. If you do, then a traditional 401(k) plan may be right for you. Consider how much you want to contribute each year, and find out if the plan will save you money on taxes.

Simone R. Johnson was born and raised in New York City. She graduated from the University of Rochester in 2017 with a dual degree in English language media and communications and film media production. She has been a reporter for several New York publications prior to joining Business News Daily and business.com as a full-time staff writer. When she isn't writing, she enjoys community enrichment projects that serve disadvantaged groups and rereading her favorite novels.
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