4 ways to save for retirement when you’re self-employed

Being self-employed gives you a certain amount of freedom, but it doesn’t give you a pass on saving for retirement. No matter how busy you get as a business owner, planning for a secure future is entirely up to you. Fortunately, there are excellent options for entrepreneurs who don’t have a regular job with benefits like a 401(k) retirement plan.

Choosing a self-employed retirement account and making regular contributions could make the difference between enjoying financial security and struggling during retirement. Here are four popular and tax-friendly ways to save for retirement when you have part- or full-time business income.

1. Traditional IRA

Individuals, including minors and seniors with earned income from a W-2 job or business, qualify for a traditional individual retirement account or IRA. For 2023, you can contribute an amount equal to your earned income, up to $6,500 or $7,500 if you’re over 50. Plus, if you have a non-working spouse, you can max out a spousal IRA annually on their behalf.

There’s no income limit to qualify for a traditional IRA, and your contributions are tax-deductible even if you don’t itemize deductions on your tax return. For example, if you earn $80,000 and contribute $6,000 to a traditional IRA, you only pay tax on $74,000 of income.

Additionally, tax on the account’s investment earnings gets deferred until you make withdrawals. There are required minimum distributions (RMDs) once you reach age 73 or 75 starting in 2033.

You can open a traditional IRA by transferring funds or rolling over a traditional retirement account with a previous employer. Then you manage every aspect of the account, including choosing investments and making contributions.

The main downside of a traditional IRA is that when you or a spouse participate in a workplace retirement plan, such as a 401(k) or 403(b), some or all of your contributions to a traditional IRA may not be tax-deductible, depending on your income.

2. Roth IRA

Anyone with earned income from a job or business (including a non-working spouse) qualifies for a Roth IRA unless their income exceeds an annual limit. For 2023, single tax filers must have a modified adjusted gross income of less than $153,000, and those married filing joint taxes must earn less than $228,000 to qualify for a Roth IRA.

If you don’t exceed the annual income limits for 2023, you can contribute an amount equal to your earned income, up to $6,500 or $7,500 if you’re over age 50.

Contributions to a Roth IRA are not tax-deductible, which means they don’t give you an upfront tax break. For example, if you earn $80,000 and contribute $6,000 to a Roth IRA, you must pay tax on $80,000 of income. But you reap the benefits in retirement when withdrawals of contributions and earnings are entirely tax-free.

Avoiding tax on decades of account growth in a Roth IRA can add up to massive savings. In general, choosing a Roth IRA in 2024 is best if your tax rate is lower now than you believe it will be in the future or if you prefer to have tax-free income in retirement. Plus, you get the full tax benefit of a Roth IRA even if you (or a spouse) participate in a workplace retirement plan.

3. SEP-IRA

If you’re self-employed and have employees or plan to hire staff someday, you might open a SEP-IRA, which stands for Simplified Employee Pension. It’s an option for any size business with or without employees.

Like a traditional IRA, contributions to a SEP-IRA are tax-deductible. You defer tax on contributions and earnings until you take distributions in retirement. However, the SECURE Act 2.0 provisions allow for creating a SEP Roth IRA in 2023. While most account custodians haven’t yet updated their systems to allow for Roth contributions, it may be an option in 2024.

With a SEP-IRA, contributions only come from you as the employer; your employees can never contribute their own money. As the business owner, you choose the amount to contribute annually. However, you must give all employees the same percentage of retirement contributions that you give yourself.

For example, if you contribute 15% of your pay to your own SEP-IRA, you’d also have to contribute 15% of each employee’s wages to their SEP-IRA (in addition to paying their total wages). But if you have a bad year with little profit, you can choose not to make SEP-IRA contributions.

A SEP-IRA allows you to make contributions in years when your business cash flow allows it and opt out when money is tight. For 2023, you can make SEP-IRA contributions for each employee (including yourself) up to 25% of each employee’s compensation for a maximum of $66,000. There are no catch-up contributions allowed for SEP-IRA participants over 50.

4. Solo 401(k)

A solo 401(k) is similar to a regular 401(k) offered by many employers, but it’s available when you’re self-employed and don’t have employees other than a spouse. You can make contributions as both an owner and employee of your business.

Solo 401(k)s are available as a traditional or Roth account, offering pre- or post-tax contributions. Like a Roth IRA, withdrawals of contributions and earnings in retirement are tax-free. But unlike a Roth IRA, you can contribute to a Roth solo 401(k) no matter how much you earn.

A solo 401(k) offers a high contribution limit, so it’s an excellent option when you have a high self-employment income and no employees other than a spouse. For 2023, you can contribute up to $66,000, or $73,500 if you’re over 50, to a solo 401(k).

Downsides of making retirement account contributions

While you get significant tax benefits from investing through a retirement account, they have a considerable downside: You must pay a 10% early withdrawal penalty if you take funds out for any reason before reaching the official retirement age of 59.5.

However, since you contribute to a Roth on an after-tax basis, you can always withdraw your original contributions penalty-free from any Roth account. But withdrawals of Roth earnings would be subject to income tax plus an early withdrawal penalty before age 59.5.

If you have business income and are unsure which retirement account is best for you, consult a financial advisor or tax professional. They can help you consider factors like your income, future earning potential, hiring plans, and retirement goals so you use a retirement plan with the most benefits for your situation.