When you set out on your own to start your own business or gig, you give up structure and job benefits in favor of freedom and flexibility.
And it’s no different with your retirement plans. People who own their own businesses have far more options, both among tax-advantaged plans and investments within them.
Consider these retirement accounts and plans as a self-employed worker, along with a few recommended service providers for each.
1. Traditional & Roth IRAs
- Best For: The newly self-employed; those looking for the simplest place to start
- Contribution Limit: $6,000 in 2021 and 2022 ($7,000 for those 50 and over)
Almost any American adult can open and contribute to a traditional IRA or a Roth IRA.
Traditional IRAs let you deduct the contribution amount on this year’s tax return. However, you must pay income taxes on the withdrawals in retirement, which includes all the compounded gains.
In contrast, you get no immediate tax deduction for Roth IRA contributions, but they grow tax-deferred. You pay no income taxes on withdrawals in retirement. Note that traditional IRAs are subject to required minimum distributions (RMDs), while Roth IRAs are not.
Traditional and Roth IRAs are exceptionally easy for several reasons:
- Standard investment brokerages: You can open IRAs at nearly any investment brokerage firm. That means you can invest in any publicly-traded asset, including stocks, bonds, REITs, ETFs, and mutual funds.
- Robo-advising available: Most robo-advisors offer them as an option, allowing you to automate your investments.
- Free options: You have free options for both traditional investment brokerages and robo-advisors. You can open the account for free, and often they come with no commissions or asset management fees.
All told, an IRA is a simple place to start as you look for ways to invest for retirement tax-free. Just remember that, as with all retirement planning accounts, the IRS hits you with an early withdrawal penalty of 10% if you pull money out of your IRA before age 59 ½.
Where to Open an Account
If you’d rather a robo-advisor manage your investments for you, try SoFi Invest, Ally Invest, Betterment, or Acorns. The latter comes with a nifty savings automation feature to help you save more and invest it automatically.
I personally use Charles Schwab, which offers both traditional brokerage and robo-advisor services for free.
To read more about these services and other strong contenders, see this breakdown of the best IRA accounts.
2. Self-Directed IRA
Best For: Professional real estate investors; advanced investors and traders.
Contribution Limit: $6,000 in 2021 and 2022 ($7,000 for those 50 and over).
Advanced investors don’t necessarily want to invest their retirement savings in publicly-traded assets like index funds or bonds. They think they can beat the market, and they want to invest in private assets that they know well.
Real estate investors are a classic example. I know real estate investors who routinely earn 20%, 30%, 50% or higher returns on their money. Even better, they have the expertise to earn those returns predictably, without the risk or volatility that comes with the stock market.
So they want to invest in real estate in their tax-advantaged retirement accounts, given their specialty expertise. And they can do so with a self-directed IRA.
But self-directed IRAs require you to pay a custodian to make sure you remain in compliance with IRS rules. Custodians often charge one-time setup fees, annual maintenance fees, and sometimes transaction fees. Which, as you can imagine, can add up quickly.
Fees aside, the regulatory compliance and rules add their own headaches and red tape.
If you have such specialty expertise that you can reliably beat the market, consider a self-directed IRA. But the barriers to entry, both in experience and sometimes in capital, make self-directed IRAs more trouble than they’re worth for the average middle-class investor. Even as a professional real estate investor myself, I don’t bother with them, given real estate’s strong existing tax benefits. I stick with a regular Roth IRA. After all, everyone should hold some stocks, so why not use a simple IRA to hold them?
Where to Open an Account
One of the more reputable real estate crowdfunding platforms is Fundrise, and they’ve partnered with self-directed IRA custodian Millennium Trust Company as a convenient and experienced custodian for real estate investments.
If you like the notion of creating a self-directed IRA to invest in real estate, but aren’t ready to buy a property directly in your IRA, you can consider buying shares in real estate crowdfunding investments. Other options beyond Fundrise include Streitwise, Diversyfund, and GroundFloor.
3. SEP IRA
Best For: Self-employed people with no employees; small family businesses; those looking for immediate tax deductions.
Contribution Limit: The lesser of $58,000 or 25% of your income in 2021 and $61,000 or 25% of your income in 2022 (no catch-up contribution for adults 50+).
The SEP IRA, short for Simplified Employee Pension IRA, is designed for self-employed people and microbusinesses. Like other Individual Retirement Accounts, you can open one at most major investment banks and can invest in any securities you like.
Unlike standard IRAs, there is no Roth option for SEP IRAs. The contribution is tax-deductible on this year’s tax return, but you must pay taxes on withdrawals in retirement.
The IRS allows you to contribute up to 25% of your net income, with a cap of $58,000. That makes it one of the more flexible retirement accounts available. Unfortunately for older adults 50 and over, SEP IRAs do not allow an additional catch-up contribution.
The twist? Whatever contribution percentage the owner sets aside for themselves, they must also contribute for their employees. There’s no employee match required — in fact, employees can’t contribute to their own accounts at all.
Since few employers want to give away an extra 25% in retirement benefits for each employee, the SEP IRA works best for solopreneurs or self-employed individuals with no employees. It also makes sense for some family businesses, where the employer doesn’t mind paying extra to look after their children’s retirement.
Where to Open an Account
Most large investment brokerages offer SEP IRAs.
4. SIMPLE IRA
Best For: Small businesses with up to 100 employees.
Contribution Limit: $13,500 in 2021 and $14,000 in 2022 ($16,500 for those 50 and over in 2021 and $17,000 in 2022).
The SIMPLE IRA offers an alternative to more complex and expensive 401(k) plans. They work well for small businesses with employees, but businesses with 100 or more employees can’t use them.
Employers must offer to contribute to their workers’ accounts, but not the exact same percentage as the owner contributes to their own. This is an advantage over SEP IRAs, which require identical contributions.
Employers can approach contributions in one of two ways:
- Offer to match employee contributions up to 3% of their income, or
- Offer to contribute 2%, regardless of the employee’s contribution.
One advantage of SIMPLE IRAs over 401(k)s is who provides them. They’re opened with regular brokerage firms, so participants can choose any securities they like.
However, unlike 401(k) accounts, you can’t roll SIMPLE IRA funds over to a standard IRA within the first two years of opening it.
Where to Open an Account
The majority of large investment brokerages offer SIMPLE IRAs.
Beware that unlike standard IRAs, many of these brokerages charge fees for SIMPLE IRAs. Double check all fees before committing.
5. Solo 401(k)
Best For: Sole proprietors and spouse businesses.
Contribution Limit: $58,000 in 2021 and $61,000 in 2022 ($64,500 for those 50 and over in 2021 and $67,500 in 2022).
When you open a 401(k) for your business, you can contribute as both the employer and the employee. That gives you up to $19,500 on the employee side in 2021 and $20,500 in 2022, or up to 100% of your income.
On the employer side, you can contribute up to 25% of net profits, capping total contributions at $58,000 in 2021 and $61,000 in 2022. You can add an extra $6,500 as a catch-up contribution if you’re 50 or older, subject to the same percentage restrictions.
The high annual contribution limits make it an attractive option, particularly for adults over 50 who can take advantage of catch-up contributions (which they can’t with SEP IRAs). And unlike SEP IRAs and SIMPLE IRAs, you can also create a Roth version of a 401(k).
In a solo 401(k), the business owner can hire their spouse, and both can contribute up to the maximums prescribed above. That can help couples really max out their tax-sheltered retirement savings.
If you have employees other than your spouse, you have to open a standard 401(k) for your business rather than a solo 401(k). You don’t have to contribute to your employees’ accounts, but you can if you wish to.
Solo 401(k)s allow account holders to invest in any asset. That includes both publicly traded securities and “alternative” investments like real estate. If you open a full-service 401(k) custodian account for a business with employees, you typically have a limited number of investment options to choose from.
Where to Open an Account
You can open a solo 401(k) at most big-name brokerages outlined above, such as Fidelity, Vanguard, TD Ameritrade, Merrill Edge, or Charles Schwab. As with the other account types, Betterment offers excellent robo-advisor service for solo 401(k)s as well. Most charge fees of some sort or another, so compare brokers before creating an account.
Some of those brokers also offer full 401(k) plans for businesses with employees. Schwab, Merrill Edge, Fidelity, and T. Rowe Price all offer strong 401(k) services. Payroll processing company ADP also offers excellent plans.
6. Defined Benefit Plan
Best For: High earners with established businesses and no employees.
Contribution Limit: Varies based on age, income, and projected retirement age.
One of the most documented and obvious ways retirement has changed in recent decades is the decline of the pension. But you can still create your own if you really want one.
Creating your own pension lets you contribute without the hard limits other plans impose. Contributions are capped based on life expectancy data, but you can likely contribute six figures tax-free each year to your plan. The IRS taxes your pension payments in retirement — there is no Roth equivalent.
It only makes sense to set up a defined benefit plan if you plan on such massive contributions. These plans come with hefty setup and maintenance fees as well as some regulatory and paperwork headaches.
You only want to set these up if you’re a solopreneur or run a family business. Generally speaking, you have to fund the pension for your employees too. That makes sense if you employ your spouse or children, but as a small-business owner, you probably don’t want to pay for your cashier’s pension.
Like other retirement plans, you can’t withdraw money before age 59 ½ or you face a 10% penalty plus back taxes.
Where to Open an Account
Unlike the other options above, few investment brokers offer defined benefit plans for small businesses.
Charles Schwab’s personal defined benefit plan is an exception. They charge a $2,250 one-time setup fee, plus an annual fee starting at $1,750 for one-participant plans. Prepare to pay more if you have any employees.
Schwab recommends against setting one up if you plan to contribute less than $90,000 per year for at least five years. Only consider a defined benefit plan if you earn an enormous income and want to maximize your contributions and tax savings.
Self-employment comes with more flexibility in choosing a tax-advantaged retirement account than W2 employees have. But self-employed people don’t enjoy the benefit of matching employer contributions. They have to fund their accounts entirely on their own.
Your ideal plan depends on your income and the size of your business. Talk to your accountant or financial advisor to discuss the best plan for you and your business. Make sure you also ask them about the possibility of adding your spouse to the plan to maximize the tax savings for both of you.