The Fundamentals of Self-Employed Retirement Plans

October 2, 2022

As a self-employed person, you’re the decision-maker behind the success of your business. The success of your business translates into your future wealth. Choosing between the different self-employed retirement plans is an important decision you can make that can help boost future wealth while reducing your tax bill! Unlike an employee, you don’t have a pre-packaged retirement account which may include a company match. Therefore, it becomes your responsibility to determine a self-employed retirement plan and how much to contribute regularly. The good news is that you have many options when it comes to choosing between self-employed retirement plans.

Think of a self-employed retirement plan as a ”work optional” plan. You may never want to retire, or maybe it’s something you haven’t planned for, or maybe it’s too far down the road to think about. Either way, optionality is key.

If you’re a self-employed small business owner and not making contributions to a retirement account, you’re leaving money on the table in the form of future wealth and tax savings. So, what types of self-employed retirement plans can benefit you?

Traditional and Roth IRAs

Let’s start with the most simple retirement account. Traditional and Roth IRA’s. These are available to anyone with earned income, not just the self-employed. If your business is getting off the ground or becoming profitable, this is a simple way to start saving for the future while potentially reducing taxes. They are easy to open at any online brokerage firm and require little work.

IRAs have the lowest contribution limit when compared to the other retirement accounts. For 2021, the contribution limit is $6,000 a year, and if you’re over age 50, you get an additional $1,000. This is the total limit for traditional and Roth IRAs combined. Meaning, you can contribute $6,000 total between a traditional and Roth IRA.

If you make eligible traditional IRA contributions, it lowers your taxable income for that year. These pre-tax contributions grow tax-deferred, and tax is due on distributions in retirement or after age 59 1/2. Early distributions are subject to penalty.

A Roth IRA, on the other hand, doesn’t offer a tax deduction when you contribute. Instead, the account has the ability to grow tax-deferred and is tax-free when you take money out after age 59 1/2. Tax-deferred growth and tax-free distributions make Roth IRA’s a powerful investing account. In addition, if you need access to Roth money before age 59 1/2, any contributions can be withdrawn at any time, penalty-free.

The downside to a Roth IRA is the income limits to make contributions. If you are eligible to make direct Roth contributions, this might be ideal while your business is still young. Roth contributions can also be beneficial if you believe you’ll be in a higher tax bracket in the future. Roth contributions today can result in substantial tax savings. If you are above the income limits and want to add money to a Roth, you’ll need to work with a financial planner on the backdoor or mega backdoor strategy.

As a self-employed business owner, having money in traditional and Roth accounts can diversify your exposure to future taxes. In addition, you can fund an IRA up to April 15 for the previous tax year! As a rule of thumb, consider making Roth contributions in lower-income years (or under income limits) and traditional IRA contributions in higher-income years.


SEP stands for Simplified Employee Pension. Don’t be confused by the word “pension.” This is an IRA but made for self-employed or small business owners with no or few employees.

As a self-employed person, contributions are generally limited to 20% of net income, up to $58,000 (2021). Net income is your net business income on Schedule C reduced by the deductible part of self-employment tax. SEP IRAs only allow for employer contributions, which is you. No catch-up contributions are allowed since these are considered “employer” contributions.

Here is a hidden perk — You may be able to make regular traditional IRA contributions into a SEP IRA. This means you can fund a SEP-IRA with contributions as the “employer” and make regular IRA contributions (as discussed in the previous section) into the SEP-IRA. Instead of funding a separate IRA account.

A SEP IRA is an attractive option if you run your business as a side hustle and have a 401(k) plan at your employer. You can fully contribute to the 401(k) then use the SEP-IRA for self-employment income.

Like an IRA, you can open a SEP IRA at many online brokerage firms, and they are fairly simple to start up.

Solo 401(k)

You’re probably familiar with a 401(k) that a company provides for employees. However, as a solopreneur or small business owner, you can also open your own solo 401(k)! A solo 401(k) is a great option for a self-employed person with no employees who want to save a much higher amount than an IRA. These self-employed retirement plans work just like an employer 401(k) plan with pre-tax contributions; earnings grow tax-deferred and then taxed when you pull money out after age 59 1/2.

The most you can contribute to a solo 401(k) is $19,500 (2021), plus an additional $6,500 if you’re over age 50.

Since you are self-employed, you’re the employer too! This means you can make “employer” contributions above the $19,500 limit. Employer contributions are up to 25% of compensation.

The maximum you can pack into a solo 401(k) is $58,000 in 2021 ($64,500 age 50 or older). This means as a self-employed person, you can potentially contribute $19,500 plus up to $38,500 of employer contributions! Add $6,500 if you are over age 50.

When determining the amount of your contribution, the max compensation you can use for 2021 is $290,000.

As a self-employed person, you likely don’t have to worry about employees. If you have employees, you can’t make solo 401(k) contributions. However, there is a way to double these large contributions potentially. Hire your spouse! Your spouse can contribute up to the standard limit of $19,500. Then you can add employer contributions up to the $58,000 total. This can increase your investments substantially while also reducing your tax bill!

A Roth solo 401(k) is also an option. Depending on business income, you might consider the Roth option when you are in lower-income years or want diversification from traditional retirement accounts.

A solo 401(k) requires more effort than a SEP and IRA to start. In addition, once your account reaches $250,000, you have to file an annual report with the IRS. However, this is likely worth the little bit of extra work with the increased savings and tax savings.

Defined Benefit Plan

A defined benefit plan a pension plan. Pension plans have fallen out of popularity over the years. However, high-earning self-employed persons may benefit from a defined benefit plan due to the ability to make large tax-deductible contributions.

A plan that has simplified this space is called a Cash Balance Benefit Plan. Instead of being calculated as a monthly annuity, it has a balance. Then, when you retire as the business owner, the account is paid out in a lump sum and rolled into an IRA!

These plans are a little more complex, and a formula determines contribution limits. If you want to maximize tax-deductible contributions, you can stack them with a 401(k)!

Brokerage Account

Let’s take a non-traditional path for this one. The accounts we have discussed so far offer tax-sheltered savings or tax deductions. A brokerage is a standard investment account that can create added flexibility. This could be retirement, future opportunities, business goals, or access to penalty-free money before age 59 1/2.

Brokerage accounts do not reduce tax by making contributions or offer tax-deferred growth. Instead, you’ll pay tax on capital gains, income, and dividends. There are no contribution limits, no income restrictions, and no age limits to access the money in exchange for fewer tax advantages. A brokerage account can be an added tool when combined with traditional and Roth accounts.

When investing in brokerage accounts, try to minimize tax drag using tax-efficient investments and tax harvesting. Tax-efficient investments include equity index exchange-traded funds (ETFs) or stocks that don’t pay high dividends. Tax harvesting allows you to reduce tax liability by strategically taking losses on individual investments.

Consider taking advantage of tax-sheltered retirement accounts first before funding taxable investment accounts.

What Plan Should You Choose?

Your self-employed business is a big investment. After all, you’re investing in yourself. Arguably the best investment you can make. You also want to diversify future wealth with retirement accounts that reward saving by reducing your tax bill! As a business owner, you don’t want to overpay Uncle Sam!

The best self-employed retirement plan for you and your business will depend on how much you can save through business income, what you want to accomplish, and the complexity you want to take on. Remember, these are only account types, not investments. You will need to determine appropriate investments to place inside of these accounts. Your investment mix should consider your personal risk tolerance and goals. If you need help navigating through the different types of self-employed retirement plans and investments, be sure to work with a CERTIFIED FINANCIAL PLANNER™ who understands your self-employment business. If you need help, let’s chat!

Are you making these common money mistakes?
This free guide breaks down 6 mistakes I see entrepreneurs make with their finances! Learn what mistakes to watch out for & how to avoid them: