Entrepreneurs and small business owners have several options for tax-advantaged retirement savings.
Using a small business retirement account in addition to a Traditional or Roth IRA can further maximize savings and tax advantages.
Owning a small business is a lot of work, and planning for retirement may feel like the last thing on your to-do list.
Getting started isn’t as hard as it seems. We’ll outline the most common self-employment retirement account options, including tips for who should consider using them, how much you can contribute, and how to set them up.
Common Sources of Self-Employment Income
While it is widely believed that you must set up a formal business, such as an LLC, to be classified as self-employed—it’s not true.
Working freelancers and independent contractors with no formal legal business structure are treated as self-employed individuals. Examples might include Uber drivers, tax preparers, and any freelance workers, such as software engineers.
The gig economy has propelled more workers than ever to venture out on their own, seeking to be their own boss and therefore managing their own retirement plan.
One Participant 401(k) Plan—Solo 401(k)
A Solo 401(k) is similar to a regular 401(k). However, with a Solo 401(k), the participant is both the employer and the employee. This means they can contribute up to the regular employee contribution limit plus up to the employer contribution limit as well.
You can also set it up as a Roth 401(k) and make non-deductible contributions now so that you can take tax-free withdrawals after retirement.
Who: Self-employed individuals who either have no employees or only employ their spouse.
How: Complete the paperwork provided by investment companies that offer Solo 401(k)s. Be sure to research, among other things, plan fees and investment fees. Note that Betterment does not currently support Solo 401(k)s.
Contribution Limits: In 2019, you can contribute up to $19,000 as the employee plus up to either 20% of the business’s net earnings or 25% of total wages as the employer—as long as your total contribution does not exceed $56,000. If you are 50 or older, you can catch up with an additional $6,000, bringing the total amount to $62,000 total. Note that if you are also participating in another employer’s 401(k) plan, the employee limits apply per person, not per plan.
Dates to Know: You must set up the account by December 31st, but you can contribute up to the April 15th tax filing deadline—or October 15th if on extension—of the following year.
Simplified Employee Pension—SEP IRA
With a SEP IRA, the business sets up an IRA for each employee. Only the employer can contribute, and the contribution rate must be the same for each qualifying employee.
Who: Self-employed or small business owners who do not qualify for a Solo 401(k), or who have employees and are looking for a low-cost retirement plan for their company.
Contribution Limits: For 2019, the business can contribute up to 25% of either the employee’s compensation or the net earnings from self-employment or up to $56,000—whichever is less. There is no catch-up amount for those 50 and older.
Dates to Know: Set up your SEP IRA by April 15th, 2020, and you can contribute for the 2019 tax year until your taxes are filed.
Savings Incentive Match Plan for Employees—SIMPLE IRA
A SIMPLE IRA is ideal for small business owners who have 100 employees or less. Both the employer and the employee can contribute.
Who: Ideal for small business owners with employees.
Contribution Limits: For qualified employees earning more than $5,000, the 2019 maximum contribution amount is $13,000. The employer can make a maximum 2% fixed contribution or a 3% matching contribution for each employee. Catch up with $3,000 extra per year if you’re 50 or older.
Dates to Know: You must open the SIMPLE IRA by October 1st of the year you wish to contribute in.
Traditional IRA or Roth IRA
In addition to one of the business-sponsored accounts described above, you can also fund a Traditional IRA or Roth IRA.
If you’re looking to use a Traditional IRA to get an income tax deduction, you may be limited in that deduction by the amount of your contributions to other retirement accounts and by the amount of your earned income.
If you’re a new business owner or entrepreneur that’s just starting out, you may find yourself in a lower tax bracket, which may mean it’s a good time to convert an old Traditional 401(k) or Traditional IRA into a Roth.
That would allow you to capture lower taxes today, and in the future when you’re in retirement and withdrawing from the Roth, there won’t be any taxes on qualified distributions. Learn more about how a Roth conversion might benefit you. You can might be able to roll over your old 401(k) into an IRA to consolidate and possibly save on fees.
Who: Anyone with earned income can contribute to an IRA.
How: Open a Roth or Traditional IRA with a bank or financial institution. Betterment offers both Traditional and Roth IRAs at a low cost. And the best part? We don’t require any paperwork to open and start funding an IRA.
Contribution Limits: For 2019, you can contribute a maximum of $6,000 per year to a Traditional or Roth IRA, or $7,000 if you’re age 50 or older. Roth contributions may be limited by your income level.
Dates to Know: You can open your IRA at any time. You have up until the April 15th tax filing deadline—no extensions—to contribute to an IRA for the preceding tax year.
How to Choose
Which tax-advantaged account should you consider using to save for your retirement? That depends on the nature and size of your small business, as well as your own age and future plans.
Here’s a scenario for a 30-year old entrepreneur with no other employees, and who is classified as a single member LLC (disregarded entity). The business nets $100,000 in 2019.
|Type of Plan||Maximum Contribution (2019)|
|Solo 401(k) plan||$39,000|
Source: IRS Publication 560
Based on this chart, you might be wondering why anyone would do anything but the Solo 401(k).
Here’s why. First, setting up a Solo 401(k) typically requires more advance planning and paperwork than opening a SEP IRA or SIMPLE IRA, either of which can usually be opened online in just a few minutes. In addition, Solo 401(k) plans require you to file Form 5500-EZ with the IRS every year once the plan reaches $250,000 in assets. And of course, with the Solo 401(k), you have to be your own company with no employees.
And remember, if your circumstances change, you may be able to roll over your Solo 401(k) plan or consolidate your IRAs into a more appropriate retirement savings account.
Betterment is not a tax advisor, and this post is not tax advice. Please seek out qualified professionals that provide advice on these issues for your specific circumstances.
When deciding whether to roll over a retirement account, you should carefully consider your personal situation and preferences. The information on this page is being provided for general informational purposes and is not intended to be an individualized recommendation that you take any particular action.
Factors that you should consider in evaluating a potential rollover include: available investment options, fees and expenses, services, withdrawal penalties, protections from creditors and legal judgments, required minimum distributions, and treatment of employer stock. Before deciding to roll over, you should research the details of your current retirement account and consult tax and other advisors with any questions about your personal situation.
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