The joys of self-employment are many, but so are the stressors. High among those is the need to plan for retirement entirely on your own. You are in charge of creating a satisfying quality of life post-retirement. When it comes to building that life, the earlier you start, the better. Luckily, there are several retirement plans for those who are self-employed.
Key Takeaways
- For self-employed workers, setting up a retirement plan is a do-it-yourself job.
- There are four available plans tailored for the self-employed: one-participant 401(k), SEP IRA, SIMPLE IRA, and Keogh plan.
- Health savings plans (HSAs) and traditional and Roth IRAs are supplemental options.
Growth in Self-Employment
Upwork's 2022 Freelance Forward survey found that 39% of the U.S. workforce are freelancers, contributing $1.35 trillion to the U.S. economy. That's up $50 billion from 2021. The percentage of workers has held steady for a year, but the type of work is changing. There was a drop in temporary workers and an increase in skilled freelancing.
While this entrepreneurial spirit is to be applauded, less laudable is the fact that 30% of those who are self-employed save for retirement sporadically while 15% aren’t even saving at all. That is a problem. If you are self-employed, you are busy but retirement savings must be a priority.
Why Saving Is Hard for the Self-Employed
The reasons for not saving toward retirement won’t be a surprise to any self-employed person. The most common include:
- Lack of steady income
- Paying off major debts
- Healthcare expenses
- Education expenses
- Costs of running the business
Setting up a retirement plan is a do-it-yourself job, just like everything else an entrepreneur undertakes. No human resources (HR) staffer is going to walk you through the company-sponsored 401(k) plan application. There are no matching contributions, no shares of company stock, and no automatic payroll deductions.
You’ll have to be highly disciplined in contributing to the plan and, because the amount you can put in your retirement accounts depends on how much you earn, you won’t know until the end of the year how much you can contribute.
Still, if freelancers have unique challenges when saving for retirement, they have unique opportunities, too. Funding your retirement account can be considered part of your business expenses, as is any time or money you spend on establishing and administering the plan. Even more important, a retirement account allows you to make pretax contributions, which lowers your taxable income.
Many retirement plans for the self-employed allow you, as a business owner, to contribute more money annually than you could to an individual IRA.
Self-Employed Retirement Saving Plans
There are four retirement savings options favored by the self-employed. Some are single-player 401(k) plans, while others are based on individual retirement accounts (IRAs). They are:
- One-participant 401(k)
- SEP IRA
- SIMPLE IRA
- Keogh plan
With all four of these options, your contributions are tax-deductible, and you won’t pay taxes as they grow over the years (until you cash out at retirement). Their complexity and suitability vary, depending on the size of your business, both in terms of personnel and earnings. Let’s look at each in more depth.
To avoid penalties with any of these plans, you’ll need to leave your savings in the account until you are 59½. However, there are certain hardship exemptions.
One-Participant 401(k)
A one-participant 401(k), as it’s officially dubbed by the IRS, also goes by the name solo 401(k), solo-k, uni-k, or individual 401(k). It is reserved for sole proprietors with no employees, other than a spouse working for the business.
How a Solo 401(k) Works
The one-participant plan closely mirrors the 401(k)s offered by many larger companies, down to the amounts you can contribute each year. The big difference is that you get to contribute as the employee and the employer, giving you a higher limit than many other tax-advantaged plans.
So if you participate in a standard corporate 401(k), you would make investments as a pretax payroll deduction from your paycheck, and your employer has the option of matching those contributions up to certain amounts. You get a tax break for your contribution, and the employer gets a tax break for its match. With a one-participant 401(k) plan, you can contribute in each capacity, as an employee (called an elective deferral) and as a business owner (an employee non-elective contribution).
Elective deferrals for 2023 can be up to $22,500, or $30,000 if age 50 or older. Total contributions to the plan cannot exceed $66,000, or $73,500 for people age 50 or older as of 2023. The limits increase for 2024; elective deferrals rise to $23,000 and $30,500 respectively. Total contributions increase to $69,000 or $76,500 for those over 50.
If your spouse works for you, they can also make contributions up to the same amount, and then you can match those. So you see why the solo 401(k) offers the most generous contribution limits of the plans.
Setting Up a Solo 401(k)
Some paperwork is required, but it’s not too onerous. To establish an individual 401(k), a business owner has to work with a financial institution, which may impose fees and limits as to what investments are available in the plan. Some plans may limit you to a fixed list of mutual funds, but a little bit of shopping will turn up many reputable and well-known firms that offer low-cost plans with a great deal of flexibility.
“Generally, 401(k)s are complex plans, with significant accounting, administration, and filing requirements,” says James B. Twining,CFP, founder and wealth manager of Financial Plan. “However, a solo 401(k) is quite simple. Until the assets exceed $250,000, there is no filing required at all. Yet a solo 401(k) has all the major tax advantages of a multiple-participant 401(k) plan: The before-tax contribution limits and tax treatment are identical.”
Order your copy of the print edition ofInvestopedia's Retirement Guidefor more assistance in building the best plan for your retirement.
SEP IRA
Officially known as a simplified employee pension, a SEP IRA is a variation of a traditional IRA. As the easiest plan to establish and operate, it’s an excellent option for sole proprietors, though it also allows for one or more employees.
How a SEP IRA Works
The employer alone contributes to a SEP IRA—not employees. So, unlike the solo 401(k), you’d only contribute wearing your employer hat. You can contribute up to 25% of your net earnings (defined as your annual profit less half of your self-employment taxes), up to a maximum of $66,000 in 2023 (increasing to $69,000 in 2024).
The plan also offers flexibility to vary contributions, make them in a lump sum at the end of the year, or skip them altogether. There is no annual funding requirement.
Its simplicity and flexibility make the plan most desirable for one-person businesses, but there’s a catch if you have people working for you. Although you do not have to contribute to the plan each year, when you do contribute, you need to do so for all of your eligible employees—up to 25% of their compensation, limited to $330,000 in 2023, increasing to $345,000 in 2024.
While SEP IRAs are simple, they are not necessarily the most effective means of saving for retirement. “You can contribute more to a SEP IRA than a solo 401(k), excluding the profit-sharing, but you must make enough money since it’s based on the percentage of profits,” saysJoseph Anderson, CFP, president of Pure Financial Advisors.
Setting Up a SEP IRA
The account is simpler to set up than a solo 401(k). You can easily open a SEP IRA online at brokerages such as Fidelity Investments.
SIMPLE IRA
Officially known as the savings incentive match plan for employees, a SIMPLE IRA is a cross between an IRA and a 401(k) plan. Although available to sole proprietors, it works best for small businesses; companies with 100 or fewer employees that might find other sorts of plans too expensive.
How a SIMPLE IRA Works
The SIMPLE IRA follows the same investment, rollover, and distribution rules as a traditional or SEP IRA, except for its lower contribution thresholds. You can put all your net earnings from self-employment in the plan, up to a maximum of $15,500 in 2023,plus an additional $3,500 if you are 50 or older. The limit increases to $16,000 for 2024 with the catch-up contribution remaining at $3,500.
Employees can contribute along with employers in the same annual amounts. As the employer, however, you are required to contribute dollar for dollar up to 3% of each participating employee's income to the plan each year or a fixed 2% contribution to every eligible employee's income whether they contribute or not.
Like a 401(k) plan, the SIMPLE IRA is funded by tax‑deductible employer contributions and pretax employee contributions. In a way, the employer's obligation is less. That's because employees make contributions even though there is that mandated matching. The amount you (as the employer) can contribute for yourself is subject to the same contribution limit as the employees.
Early withdrawal penalties are hefty at 25% within the first two years of the plan.
Setting Up a SIMPLE IRA
As with other IRAs, you must open these plans with a financial institution, which has rules as to what kinds of investments can be purchased. They may also charge plan administration and participation fees. The process is similar to a SEP IRA, but the paperwork is more complicated.
Keogh Plan
The Keogh or HR 10 plan (more commonly referred to today as a qualified or profit-sharing plan) is arguably the most complex for self-employed workers. But it also allows for the most potential retirement savings.
How a Keogh Works
Keogh plans usually can take the form of a defined-contribution plan, in which a fixed sum or percentage is contributed every pay period. In 2023, you can contribute up to 25% of compensation or $66,000. In 2024, the limit increases to $69,000. Another option, though, allows them to be structured as defined-benefit plans. In 2023, the maximum annual benefit was set at $265,000 or 100% of the employee’s compensation, whichever is lower. In 2024, the limit increases to $275,000.
A business must be unincorporated and set up as a sole proprietorship, limited liability company (LLC), or partnership to use a Keogh plan. Although all contributions are made on a pretax basis, there may be a vesting requirement. These plans benefit high earners, especially the defined-benefit version, which allows greater contributions than any other plan.
Setting Up a Keogh
Keogh Plans have federal filing requirements, which can mean complex paperwork. As a result, it's best to seek professional help from an accountant, investment advisor, or financial institution. Your options for custodians may be more limited than with other retirement plans, which means you'll probably need a brick-and-mortar institution rather than an online-only service. Charles Schwab is one brokerage that offers and services these plans.
A Keogh is best suited for firms with a single high-earning boss or two and several lower-earning employees—as in the case of a medical or legal practice.
Health Savings Account (HSA)
As a freelancer, you may have to pay for your health insurance. The deductibles for individual medical plans tend to be high. If that’s your situation, consider opening a health savings account (HSA). Though created for medical expenses rather than retirement years, an HSA can function as a de facto retirement account.
How a Health Savings Account Works
HSAs are funded with pretax dollars, and the money within them grows tax-deferred as with an IRA or a 401(k). While the funds are meant to be withdrawn for out-of-pocket medical costs, they don’t have to be, so you can let them accumulate year after year. Once you reach age 65, you can withdraw them for any reason. If it’s a medical one (either current or to reimburse yourself for old costs), it’s still tax-free. If it’s a non-medical expense, you are taxed at your current rate.
To open an HSA, you have to be covered by a high-deductible health insurance plan (HDHP). For 2023, the Internal Revenue Service (IRS) defines a high deductible as $1,500 per individual and $3,000 per family. For 2024, the deductible increases to $1,600 and $3,200, respectively.
Also, the annual out-of-pocket expenses, including deductibles, and co-payments, but not premiums, must not exceed $7,500 for self-only coverage or $15,000 for family coverage for 2023. The limit increases to $8,050 and $16,100, respectively.
The annual contribution limit for 2023 contribution limit is $3,850 for individuals and $7,750 for families. In 2024, the limit increases to $4,150 and $8,300, respectively. People aged 55 and older are allowed a $1,000 catch-up contribution.
Traditional or Roth IRA
If none of the above plans seems a good fit, you can start your own individual IRA. Both Roth and traditional individual retirement accounts (IRAs) are available to anyone with employment income, including freelancers. Roth IRAs let you contribute after-tax dollars, while traditional IRAs let you contribute pretax dollars.
In 2023, the maximum annual contribution is $6,500, $7,500 if you are age 50 or older, or your total earned income, whichever is less.In 2024, the limits increase to $7,000 and $8,000 for those over 50.
Most freelancers work for someone else before striking out on their own. If you had a retirement plan such as a 401(k), 403(b), or 457(b) with a former employer, the best way to manage the accumulated savings is often to transfer them to a rollover IRA or a one-participant 401(k).
Rolling over allows you to choose how to invest the money rather than being limited by the choices in an employer-sponsored plan. Also, the transferred sum can jump-start you into saving in your new entrepreneurial career.
Managing Your Retirement Funds
It's important to start saving for retirement as soon as you begin earning income, even if you can't afford to save that much at the beginning. The sooner you begin, the more you'll accumulate, thanks to the miracle of compounding.
As your savings build, you may want to get the help of a financial advisor to determine the best way to apportion your funds. Some companies even offer free or low-cost retirement planning advice to clients. Robo-advisors such as Betterment and Wealthfront provide automated planning and portfolio building as a low-cost alternative to human financial advisors.
What Are Ways to Set Yourself Up for Retirement?
The best way to set yourself up for retirement is to save money and not incur high-interest debt. From there, you can craft specific retirement plans. Saving money first will allow you to create an emergency fund, which will help you financially in case you lose your job or have a medical emergency. An emergency fund will prevent you from going into debt. High-interest debt particularly will eat into savings and retirement.
From there, you can contribute to retirement plans. If your employer has a 401(k) or similar plan, start contributing to that account, especially if they match contributions. You can also contribute on your own to a traditional IRA or Roth IRA.
At What Age Should You Start Thinking About Retirement?
You should start thinking about retirement as early as you can. Ideally, in your 20s, which is when a lot of people start working full-time after graduating from college. Some people start working full-time even before that, which is also a good time to start thinking about retirement. The earlier you start planning for retirement, the more your money will grow due to compounding interest. This will provide you with more money in your retirement years.
Can You Contribute to a 401(k) and an IRA?
Yes, you can contribute to both a 401(k) and either a traditional IRA or a Roth IRA. 401(k)s and IRAs are two separate types of retirement accounts and you can contribute to both if you'd like. A 401(k) is offered by an employer and IRAs can be done on your own.
The Bottom Line
Creating a retirement strategy is vitally important when you are a freelancer because there’s no one looking out for your retirement but you. That’s why your mantra should be "pay yourself first."
Many people think of retirement money as the money they put away if there is any cash left at the end of the month or year. “That’s paying yourself last,” says David Blaylock, CFP, head of advice and planner compliance at Origin. “Paying yourself first means saving before you do anything else. Try and set aside a certain portion of your income the day you get paidbeforeyou spend any discretionary money.”
