Disclaimer: The following information is applicable to the year 2017 and will change in the future as the tax code evolves over time.
For most individuals, retirement saving options are limited to those provided through their employer. When working for a company, you are stuck with the benefits package given to you, whether you like it or not. Investment options tend to be limited and expensive, with little assistance (if any) provided to help you along your retirement saving journey.
However, for the growing population of self-employed individuals and side-hustlers, there are plenty of retirement saving options available to fit your business and personality. Much like the flexibility you may feel in owning your own business, you are able to craft the retirement plan to fit you.
Are these options only available to full-time self-employed individuals?
No! Even if you have a little side-hustle that creates self-employed income, you can take advantage of these retirement saving vehicles outside your full-time employer’s plan. However, contributions you make to your full-time job’s plan will affect contributions you can make to another plan.
Before we get started, a few attractive investment options available to everyone should be utilized first before you begin setting up a formal retirement plan - IRA and HSA. Between an IRA ($5,500) and a Health Savings Account ($3,400 for singles, $6,750 for families), you can save thousands of dollars for retirement before having to worry about extra rules and regulations that come with the retirement plan options discussed here.
The holy grail of retirement saving vehicles, in my humble opinion. The “Solo-401(k)” or “Individual-401(k)” allows you to maximize your retirement saving, with far more flexibility in investment options than most receive with their employer’s plan. With a Solo-401(k), you can make total contributions up to $54,000 (or $60,000 for those age 50 and older). Of these contributions, you can make annual contribution deferrals of $18,000 (plus an additional $6,000 for those 50 and older) as the employee of your plan. Plus, you can contribute up to 25% of your net earnings from self employment until you reach the total maximum contribution of $54,000 each year.
- $18,000 (plus $6,000 catch-up) as Employee
- 25% net earnings from self-employment as Employer
- Total combined contributions limit of $54,000 ($60,000 if age 50 and older)
For the contributions made as employee (up to $18,000), you can elect to have these go in as Roth or Traditional contributions. The Roth contributions will be taxed today, but receive tax-free distributions in the future. The Traditional contributions are pre-tax today, but are taxed as ordinary income when distributions are received in retirement. All of the contributions made as the employer must go in as Traditional pre-tax contributions.
Solo-401(k) plans are designed specifically for the self-employed that do not have any employees (hence the name solo/individual). However, you can include your spouse in the plan. If you carefully distribute income to both yourself and your spouse, your contribution limit now doubles to $108,000 (or $120,000 if both age 50 and older).
As for investment options within a Solo-401(k), you choose! You can open a Solo-401(k) at most brokerage firms or through your financial planner. You can also open the account directly at Vanguard, for those that love saving on fees.
All-in-all, the Solo-401(k) provides high contribution levels and flexibility in your investment options, which is a win-win in my book.
Simplified Employee Pension (SEP)
Simplified Employee Pension (SEP) accounts are beneficial to the self-employed that have employees, desire simplicity, and want high contribution limits. The SEP allows you to make contributions up to $54,000 or 25% of net income from self-employment. One caution with the SEP is that whatever percent contribution you give yourself, you must give to your employees that are eligible for the plan.
These plans are easy to setup and can even be opened after year-end. If you decide you’d like to open a SEP before you file your income tax due date (including extensions), you can do so. All contributions to a SEP are pre-tax, with no Roth option available to you or your employees.
Investment options are also attractive with a SEP, you can open a SEP at most brokerages or through your financial planner, and have great flexibility in finding low-cost investment options.
SEP plans can also be opened through insurance companies that offer annuities, which I do not recommend. These plans will often be riddled with high fees and have limited investment options. This is not good for you or your employees.
Savings Incentive Match Plan for Employees (SIMPLE) IRA plans (that’s a mouthful) offer an ease of administration (like the SEP) but with lower employee matching requirements.
With a SIMPLE, the contribution limit is $12,500 ($15,500 for age 50 and older) plus a 3% employer match. As the employer, you can declare one of two options for matching your employee’s contributions - 3% match (meaning the employee has to contribute 3% to receive your matching contribution) or 2% fixed contribution (meaning you give your employee 2% of their income regardless if they contribute themselves). All contributions to a SIMPLE IRA are pre-tax, like a SEP.
One major benefit with a SIMPLE IRA is that if you are operating a small side-hustle with no employees and want all of your net earnings to go towards boosting your retirement, you can. For example, if you are earning $1,000 per month (net income) from your side hustle, 100% of those earnings can go into your SIMPLE IRA account.
SIMPLE IRA’s receive the same benefits of being easy to administer like the SEP and great flexibility in investment options. Like the SEP, be wary of opening this plan at an insurance company, as fees can be much higher and investment options more limited than you can get elsewhere.
Finally, SIMPLE IRA’s are great for the small business owner or side-hustler that wants a (simple) retirement plan to offer themselves and their employees with lower contribution limits and matching requirements.
Which Plan Is Best For You?
These 3 options are going to be the best retirement plan options for the vast majority of self-employed individuals. There are a few more options available, but I believe these should be considered first, as they offer the most flexibility and ease of administration to entrepreneurs.
Total plan contribution limits vary based on your net income from self-employment, as mentioned a few times above. Here you can see how these contribution limits come into play at various income levels (based on 2017 limits, 25% contribution level, age 35 individual):
- $25,000 Net Income
- Solo-401(k) - $20,616.90
- SEP - $4,646.76
- SIMPLE - $13,192.63
- $100,000 Net Income
- Solo-401(k) - $36,587.05
- SEP - $18,587.05
- SIMPLE - $15,270.50
- $200,000 Net Income
- Solo-401(k) - $54,000.00
- SEP - $37,887.09
- SIMPLE - $18,041.00
Each retirement plan option should be taken into consideration before making your final decision. This is where a real financial planner can provide a huge benefit to you. Here is a quick summary of which option may be best for different goals:
- Highest Contribution & Roth Option - Solo-401(k)
- Ease of Administration & Higher Contribution - SEP
- Ease of Administration & Lower Matching for Employees - SIMPLE