4 Best Retirement Plans For Self-Employeds

These retirement plans are great for those who are self-employed.

Small business owner with an open sign.
These retirement plans are great for small business owners. Jose Luis Pelaez Inc/Blend Images/Getty

There are several types of retirement plans available to choose from if you are self-employed. The right one will depend on how much you want to contribute, and if you have or plan to have employees. The four retirement plans listed below are the most widely used retirement plans for those who are self-employed.

1. SEP – Self-Employed Pension Plan

The SEP, or Self-Employed Pension Plan, is a great retirement plan if you have no employees.

Paperwork to open this type of plan is minimal. Most investment companies, brokerage firms, and large banks will offer a version of the SEP for small business owners.

Maximum contribution: lesser of 25% of earned income or $54,000 in 2017. (It was $53,000 in 2015 and 2016.)

Required contributions: None. If you have employees and they are eligible you are required to contribute the same percentage of their contribution to their SEP account, as the percentage of your compensation that you contribute to your SEP account.

If you later get employees you will have to make a contribution for them if they:

  • Have worked for you 3 of the past 5 years
  • Earn more than $600 a year in 2015, 2016 and 2017 ($550 a year in 2014)
  • Are age 21 or greater

Learn more from the IRS with Retirement Plan FAQs Regarding SEPs.

2. Individual(k) With Profit Sharing

This Individual(k) plan is a simplified version of a traditional 401(k) plan.

It is a retirement plan designed just for self-employeds who have no employees which means it works well for businesses with only one owner/employee, or for businesses where a husband and wife are the only owner/employees.

This plan allows two types of contributions: a salary deferral contribution and a profit sharing contribution.

With the salary deferral portion of the contribution, some plans give you the choice of making a traditional, tax-deductible contribution, or of setting up a plan that allows a Roth (after-tax) contribution. The salary deferral portion of the contribution must be made by about January 15th of the year following the calendar year the contribution is for.

The profit sharing portion of the contribution can be up to 25% of earned income (net income after business expenses). This cannot be calculated until the year is over and some other tax calculations have been made. You have until your tax filing deadline plus extensions to make the profit sharing portion of your contribution.

Maximum salary deferral contribution: $18,000 for 2015, 2016, and 2017 ($17,500 for 2014). If you are age 50 or older, you can contribute an additional $6,000 as a salary deferral catch-up contribution in 2015, 2016 and 2017 (was $5,500 in 2014).

Maximum profit sharing contribution: 25% of earned income, but total contributions (salary deferral plus profit sharing) to this plan cannot exceed $54,000 for 2017 / $53,000 for 2015 and 2016 / $52,000 for 2014 (On top of this you can add the catch-up salary deferral contribution if you are eligible to make that.)

Because this plan allows two types of contributions, in some cases you can put more money away on a tax-advantaged basis with an Individual(k) plan than with a SEP, even if you make the same amount from year-to-year.

For example: let’s say you make $100,000 net of all expenses:

  • With a SEP you can contribute $25,000.
  • With an Individual(k) you can contribute $18,000 as a salary deferral plus $25,000 as a profit sharing contribution.
    (The calculation is not quite as simple as this as you must take into account self-employment tax. You need to ask your tax preparer to determine your final allowed contribution amount.)

Required contributions: None. You have the choice of making a salary deferral contribution, profit sharing, both or neither. If you have employees that become eligible, you will have to change plans and make contributions for them.

Most investment companies, brokerage firms, and large banks will offer a version of the Individual(k) plan, but not all will allow for Roth contributions.

If you get employees you will have to either terminate your plan or amend your plan to a Traditional 401(k) plan where you will have to make contributions for them if they:

  • Have worked more than 1,000 hours in the year
  • Have worked for you more than one year (you can set this limit to two years if they are 100% vested in employer contributions once those contributions are made
  • Are age 21 or older

3. Defined Benefit Plan

A defined benefit plan is a good choice if you are making a substantial amount of money and want to contribute a lot more than you are allowed to contribute to a SEP or Individual(k) Plan. With this type of plan, you must have what is called a third-party administrator or actuary, who helps determined the amount and timing of your contributions.

Maximum contribution: Defined benefit plan contributions are determined by your plan administrator based on a formula, so the maximum contribution will vary from person to person depending on the terms of your plan.

Required contribution: Contributions are required each year, and the contribution amount is usually substantial. This type of retirement plan is best for a self-employed person or business that has steady profits and wants to put away a large amount of money each year on a tax-deductible basis.

If you get employees, you will have to make contributions for them according to the terms outlined in your plan document. Generally, employees become eligible for contributions when they:

  • Have worked more than 1,000 hours in the year
  • Have worked for you more than one year (you can set this limit to two years if they are 100% vested in employer contributions once those contributions are made
  • Are age 21 or older

4. SIMPLE Plan

This SIMPLE plan is a good choice if you are a small business with employees, you want to contribute to a retirement plan, but don’t want to be burdened with an onerous required contribution for employees, or saddled with high administration fees for your plan.

Maximum salary deferral contribution: $12,500 for 2015, 2016 and 2017 ($12,000 in 2014). If you are age 50 or older you are eligible to make an additional $3,000 catch up contribution in 2015, 2016 and 2017 ($2,500 in 2014).

If you get employees you will have to make contributions for them when they have worked for you for the two preceding years and earned $5,000/year or more each of those two years.

For any eligible employees you are required to do one of the following:

  • Mandatory matching contribution: $1 for $1 up to the first 3% of each participating employee's compensation. With this option, you only contribute to their plan if they are contributing themselves.
  • 2% non-elective contribution for all employees: with this option, you make a contribution for all employees who meet the eligibility requirements, even if they are not contributing money themselves.