3 Retirement Plans Every Entrepreneur Needs To Know About

Now That You're Self-Employed, How Do You Plan For Retirement?

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Whether you're just entering the workforce as a newly minted entrepreneur or freshly self-employed after years of being in the traditional workforce, there's no doubt that you have a laundry list of things that need to get done. From the daily machinations of setting up computer systems and phone lines for your business to the big picture plans for your new company, it probably seems as though there are not enough minutes or hours in the day.

However, when you are setting up your new business, one important piece of the pie is to set up your retirement account. Learn more about your retirement options.

Key Takeaways

  • When you're self-employed, you have several options for funding your retirement, including a Simplified Employee Pension (SEP) IRA and individual 401(K).
  • If you have employees, you can save for yourself while also offering your staff matched contributions (up to 3%) with a Savings Incentive Match Plan for Employees (SIMPLE) IRA.
  • The rules, penalties, and contribution limits vary by plan, so check carefully before contributing.

Retirement Planning for the Self-Employed

If you are a young entrepreneur in your 20s or 30s, retirement is probably the last thing on your mind. You may not even be able to envision yourself retiring. After all, you’ve only just begun! But it’s critical to have the right strategies in place for retirement. After all, you don’t want to strike it rich with your startup and then have nothing to show for it when you reach 65.

While you won't have a company plan to help make your decisions, there are a number of retirement account options for self-employed workers and small business owners. 

The three most common types of plans that financial advisors recommend for entrepreneurs and small business owners are:

  • Simplified Employee Pension (SEP) IRA
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA
  • Individual 401(k)

Not only do these choices offer everything you need for your retirement plan, but some options also can be utilized if you're a small business owner with employees. Offering a solid retirement plan can be a key component when it comes to attracting and retaining good employees. 

Simplified Employee Pension (SEP) IRA

For sole proprietors, a Simplified Employee Pension or SEP IRA is very popular. It’s an easy account to open and annual account fees are low or even non-existent. The rules on contributions are also simple—you can invest as much as 25% of your net income up to a cap that changes periodically to keep up with inflation. The cap is $58,000 for 2021, increasing to $61,000 in 2022.

Contributions are tax-deductible and the SEP IRA also offers some funding flexibility. It’s possible to wait until after you’ve filed your taxes to fund the account, so if your income is higher than you thought, you can make a larger contribution and lower your tax bill. If you have employees, they cannot contribute to the SEP IRA, but they can make their own contributions to a traditional or Roth IRA.

Savings Incentive Match Plan for Employees (SIMPLE) IRA

If you’re currently running your own business but looking to expand, the SIMPLE IRA may be the account you need. With this type of account, you can continue investing even after you’ve hired an employee, but you have to match your employees’ contributions, up to 3% of their pay. There’s also a contribution limit of no more than $13,500 a year in 2021 or $14,000 in 2022. Those who are 50 or older can contribute an additional $3,000 each year. This is an additional catch-up contribution just for older savers.

Be aware that should you make a withdrawal from a SIMPLE IRA account within two years of opening it, there will be a 25% penalty.

Individual 401(k)

For those hoping to build up their retirement account quickly and who have a lot of money to contribute, an Individual 401(k) is a popular option. It works a lot like a Traditional 401(k), but your spouse can join the plan. Acting as your own employee, you’re able to contribute as much as $19,500 to your individual 401(k) in 2021 or $20,500 in 2022. You can contribute an additional $6,500 in 2021 and 2022 if you're over age 50.

However, this plan is not available to additional employees; you can only use it you're a sole proprietor and/or your spouse works with you.

When you’re the boss, you can contribute an additional 25% of compensation in addition to your employee contribution to a $58,000 maximum for 2021, $61,000 for 2022. Because there’s no other restriction on those contributions, you can make them when your business is doing extremely well to make up for the years when it was harder to make such large contributions.

If you have a spouse in the plan, it’s possible for the two of you to double up on those contributions, including the higher limit for catch-up contributions if you’re both 50 or older.

This type of account is also beneficial if you think you might need to take out a loan for your business. Rules will vary, but generally, you can take out half of the account’s balance (up to $50,000) and take five years to pay it back.

The Bottom Line

For the self-employed individual, these plans are relatively low cost and easy to administer. As a first step, you may want to consult with your financial advisor to determine which plan is right for you and your business.

As you compare plans, consider the range of investment options and the fees associated with those investments and with managing the account. And of course, one major factor to consider is whether you need a retirement plan option that allows employees to participate if your small business is supported by a team.