Whether you are self-employed or the owner of a small business, there is a wide range of retirement plans designed to meet your specific needs. The plan you choose depends on the size of your business, how it is structured and how much money you think you can afford to put aside. Self-employed individuals can take advantage of the fact that they’re considered both employer and employee.
1. Traditional IRA
If you just want a simple retirement vehicle with flexibility of contributions, a traditional IRA could be a great option. You can set up a traditional IRA at any bank or financial institution with minimum paperwork. The maximum contribution for 2020 is $6,000 ($7,000 if you are age 50 or older) and the contribution is tax deductible. However, this deduction may be limited if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels.
2. Roth IRA
Roth IRAs have the same contribution rules than traditional IRAs. The main difference is that Roth IRA contributions are not tax deductible, but they offer tax-free growth and tax-free withdrawals in retirement. Roth IRA rules dictate that as long as you’ve owned your account for 5 years and you are age 59½ or older, you can withdraw your money when you want to, and you won’t owe any federal taxes. If you find yourself in a position where you may need to withdraw funds prior to 59 1/2, be sure to consult your financial planner to see if any penalty-free options exist for your situation.
3. Simplified Employee Pension Plan, or SEP IRA.
A SEP IRA can be a very powerful tool for very small or owner-only businesses, because it can allow you to put aside a lot of money with very little expense or paperwork.
All contributions for SEP IRAs are made by the employer. You must make the contributions for everyone and can’t exclude any employee. The maximum contribution can’t exceed the lesser of $57,000 for the 2020 tax year or 25% of the employee’s compensation. For self-employed individuals, the IRS defines compensation as your net earnings from self-employment, reduced by one-half of your self-employment tax and by your entire SEP-IRA contribution, up to a compensation limit of $285,000 for 2020.
Also, you don’t have to contribute every year. If you are having a down year, you can contribute a small amount or not at all.
4. Savings Incentive Match Plan for Employees, or SIMPLE IRA.
The Savings Incentive Match Plan for Employees of Small Employers, or SIMPLE IRA, could be a great choice if you want to contribute to a retirement plan and you have a small company — fewer than 100 employees.
An employee may choose to contribute, but an employer must contribute annually. An employee can contribute up to $13,500 in 2020 ($16,500 for those age 50 and over).
Employers must make some form of a contribution to employees’ accounts. An employer can choose to either make a dollar-for-dollar match of up to 3% of a worker’s pay or contribute a flat 2% of compensation, whether the employee contributes or not. If the employer has a down year, the matching contribution can be reduced to less than 3%, but the contribution must be at least 1% and this exception is only allowed in 2 out of 5 years.
5. Individual 401(k)
An Individual 401(k)—also known as a solo 401(k)— can maximize your savings if you’re self-employed or run an owner-only business. The best thing about the Individual 401(k) is that you can maximize contributions even if your income is low, because, unlike other plans, you can contribute up to 100% of your income. The paperwork and costs of opening an Individual 401(k) are very limited. When your savings reach $250,000, you do have to file a Form 5500 annually, but you can avoid this by opening a second or more accounts and maintaining the balance of each account below $250,000.
As a business owner, you can contribute both as an employer and employee and you can contribute 100% of your income. The combined amount of employer plus employee contributions can’t exceed $57,000 for the 2020 tax year ($63,500 if age 50 or older).
6. Individual Roth 401(k)
Roth accounts within your 401(k) take after-tax contributions. That means that, like Roth IRAs, any money you put into a Roth 401(k) is not tax-deductible. However, like withdrawals from a Roth IRA, withdrawals from a Roth 401(k) account are tax free. The contribution and paperwork rules are the same than for Individual 401(k)s.
There’s a lot to consider when choosing a retirement plan as a small business owner. If you have employees, you’ll need to decide if your plan will cover them as well as yourself. Consult with your CPA or Financial Planner to help you nail down your retirement plan and to build an investment plan.