Self-Employed Retirement Plans: What Are Your Options and How to Choose the Best One For You

When you move from working for a company to being self-employed, you’ll have to opt for a new retirement plan. In most cases, self-employed individuals roll their previous plans into a new one—often choosing a SEP (Simplified Employee Pension) IRA. That said, every self-employed retirement plan option has a different set of terms, conditions, and deposit limits, so it’s wise to become familiar with these choices before determining which is best for you. 

Below, we walk through the retirement plans available to self-employed workers—including their benefits and drawbacks!—with the help of asset optimization and retirement strategist Teresa Villaruz. 

Retirement plans for self-employed individuals: Know your options

The main types of retirement plans for self-employed individuals are: a solo 401(k), a Roth IRA, and a SEP IRA. 

A SEP IRA

Now, what is a SEP IRA for self-employed? A SEP IRA is a retirement account that lets you contribute up to 25% of your net earnings from self-employment, with a maximum limit of $69,000, as of 2024. While it doesn’t allow for catch-up contributions at any age, it’s a preferred choice for small business owners. 

“SEP IRAs are easy to set up and manage with minimal paperwork,” Villaruz says. “It’s great for small business owners because it has high contribution limits and minimal hassle.”

Pros of a SEP IRA

• High contribution limits, up to 25% or your income with a $69,000 maximum

• Contributions are tax deductible 

Cons of a SEP IRA

• If you hire employees, you’ll have to contribute the same percentage of salary to their plan as you do for yourself

• No catch-up contributions

• Withdrawals are taxed as ordinary income

• There’s a penalty for withdrawals before 59 ½ years of age

• Investments are limited to stocks, bonds, and mutual funds

Solo 401(k) 

You might be wondering, what is a solo 401k for self-employed? It's similar to a regular 401(k), which is what most employers offer their employees. But this account type (also called a one-participant 401(k) plan) is designed for business owners with no employees other than a spouse, says Villaruz, and you can contribute both as an employer and as an employee, which allows you to save more money.  

Solo 401(k) accounts also allow “catch-up contributions”—additional money put into the account—if you’re 50 years of age or older. 

The total combined limit for a solo 401(k)—assuming you contribute as an employee and employer—is $69,000, or $76,500 with catch-up contributions, Villacruz says.

Pros of a solo 401(k): 

• High contribution limits of up to $69,000 or $76,500 if you’re over 50

• Catch-up contributions

• Contributions are tax deductible 

• A wide range of investment options—including stocks, bonds, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), money market funds, and more. 

Cons of a solo 401(k):

• This account type is only available if your business has no other employees, besides your spouse

• Complex paperwork, in some cases

• Management fees on these accounts can be more costly

• Your withdrawals are taxed as ordinary income

• There’s a penalty for withdrawals before 59 ½ years of age (usually 10%)

A Roth IRA

As of 2024, Roth IRAs have a contribution limit of $7,000 per year from after-tax dollars, Villaruz says. Qualified withdrawals from a Roth IRA account are tax-free too, meaning the account has to be open for at least five years and the account holder is at least 59 ½ years old. 

Roth IRA contributions are made with after-tax dollars, and as of 2023, the adjusted gross income limit for a single person to have a Roth IRA is $153,000, and $214,000 for a married couple, says the IRS.  

“If you don’t plan on contributing more than $7,000 in a single retirement plan, then a Roth IRA could be a good option for you,” she says. “Also, since it’s funded with after-tax dollars, the growth and distribution is tax-free, except in Michigan and Mississippi.”

Pros of a Roth IRA: 

• Qualified withdrawals are tax-free, as are earnings

• Flexible withdrawals, meaning you can take money out at any time without penalty

• No age limit on contributions, you can contribute for as long as you’ve earned income

Cons of a Roth IRA: 

• Contributions limits are relatively low, compared to SEP IRAs and solo 401(k)s

• No immediate tax deduction

• Adjusted gross income limits of $153,000 for a single person and $214,000 for a married couple

How to choose a self-employed retirement plan 

So, which retirement plan is best for self-employed individuals? It depends. To choose the right self-employed retirement plan, take a close look at your situation and consider the following factors: 

Income and contribution limits

The income and contribution limits of an account are the most significant factor to consider when choosing a retirement account. For high-income individuals, Villaruz leans towards a solo 401(k) because of the higher contribution limit. For moderate income, a SEP IRA or Roth IRA may be a simpler choice, given their contribution and tax benefits.  

Taxation 

You may also want to take into account your current and future tax bracket when retirement planning. 

“If you expect to be in a higher tax bracket in retirement, a Roth IRA is advantageous,” Villaruz says. That’s because you won’t get taxed on the money you withdraw at that time. “But if you want to reduce your taxable income now, a SEP IRA or solo 401k is better, since contributions are tax deductible.” 

Contribution flexibility 

When you have variable income, a SEP IRA offers flexibility in how much you can contribute each year. For those who want to maximize their contributions, a solo 401(k) allows you to save more if you have the means to. 

Access to funds 

Finally, think about when you might need the money in these accounts and whether or not you can wait until you’re a certain age to withdraw it. 

“If you need access to your contributions before retirement, a Roth IRA allows you to withdraw contributions (not earnings) without penalty,” Villaruz says. The other two options do not offer that flexibility. 

Mistakes to avoid when choosing a self-employed retirement plan

In terms of what to avoid when deciding on a self-employed retirement plan, Villaruz has a list of common mistakes.

1. Not understanding the current and potential future of retirement and the effects of the three killers of retirement accounts: taxation, inflation, and market or economic volatility

2. Self-employed individuals might contribute less than they can afford, not realizing the impact this can have on their retirement savings. It’s essential to maximize contributions, especially in years with higher income.

3. Choosing the wrong type of plan without understanding the tax benefits or consequences can be costly.

4. Investing too heavily in one type of asset or neglecting to diversify can increase risk.

5. Self-employed income can fluctuate, making it challenging to contribute consistently. Not planning for these fluctuations can result in inconsistent contributions and lower overall savings.

6. Retirement plans should be reviewed regularly to ensure they align with changing financial situations and goals. Failing to adjust contributions, investment strategies, or plan types can hinder growth and preparedness for retirement.

7. Not paying attention to the fees associated with different retirement plans can eat into returns. It’s important to understand and manage these costs to maximize savings.

8. Not considering how retirement assets will be transferred to heirs can result in higher taxes and complications. Proper estate planning ensures smooth and tax-efficient transfer of wealth.

Whichever retirement plan you choose, experts recommend you learn the rules, limits, and benefits of your account so you can get the most out of it. For those desiring extra help, meeting with a fee-only financial advisor can help you make the right decision for your current and future self!