Best retirement plans for the self-employed

Whether you're a freelancer, small business owner or consultant, joining the ranks of the self-employed can be an exciting move. However, with this independence comes some unique challenges—like saving for retirement on your own.

The good news is there are several tax-advantaged retirement savings accounts to choose from. Learn about the most popular retirement plans for the self-employed and business owners to decide which option best fits your financial situation and long-term goals.

How to save for retirement if you're self-employed

For self-employed individuals and freelancers, saving for retirement often requires more upfront research and planning. Tasks that are typically handled by an employer—such as selecting a tax-advantaged plan, making contributions and keeping up with IRS rules—now fall to you.

If you don't already have a clear plan, your first step should be to set a retirement savings goal. Establish a target so you can estimate how much you may need to contribute each year to stay on track.

The next step is deciding where to save. Several self-employed retirement options are available, including various types of IRAs and other tax-advantaged plans designed for business owners.

Each of these plans has its own eligibility requirements, tax advantages and contribution rules. Contribution limits may also change from year to year as the IRS adjusts them for inflation.

Comparing retirement plans for the self-employed

It's important to understand how each of these self-employed retirement options work—along with the advantages and trade-offs of each—so you can choose the option that best fits your financial situation and long-term goals.

IRAs

IRAs are a type of tax-advantaged account designed to help you save money for retirement. There are two types of IRAs to choose from—traditional and Roth—and the rules, tax benefits and limitations vary between the two. If this is your first time setting up an account, it's a good idea to start by learning the basics of how IRAs work.

How IRAs work

IRAs allow you to buy and sell a range of investments, much like a regular brokerage account. As long as you earn taxable income during the year, you're eligible to open an IRA. In many cases, you can also contribute to an IRA in addition to another self-employed retirement plan.

Primary benefits of an IRA

• The steps to open an IRA are fairly straightforward and can be done through many banks and brokerages.
• If you meet certain conditions outlined by the IRS, you may be eligible to take penalty-free IRA withdrawals for qualified expenses.
• You'll have the option to roll over retirement savings from a previous employer into a new IRA.

Potential disadvantages

• Roth IRA eligibility begins to phase out at certain income levels and is prohibited at higher levels.
• Both traditional and Roth IRAs have relatively low limits for annual contributions, plus a $1,100 catch-up contribution for those 50 and older.
• If you or your spouse can access a workplace retirement plan, you may be limited in your ability to deduct contributions to a traditional IRA on your tax return.

SEP IRAs

Simplified Employee Pension IRAs, or SEP IRAs, are a popular option for freelancers, solopreneurs and business owners with just a few employees. You'll have the ability to choose between a traditional and Roth version of a SEP IRA. With a Roth, contributions aren't deductible, but qualified withdrawals are tax-free.

How SEP IRAs work

With a SEP IRA plan, you'll set up an IRA for yourself and any eligible employees. Contributions are based on a set percentage of each individual's salary, which you'll determine. Your business will be responsible for making contributions into each account annually.

Primary benefits of a SEP IRA

• SEP IRAs are easy to set up and administer, with no required annual reporting to the IRS.
• Annual contribution limits are higher than other IRAs, allowing you to contribute up to 25% of net self-employment earnings—subject to the IRS maximum.
• Individual retirement contributions may be a tax-deductible business expense.

Potential disadvantages

Equal contributions are required, so the percentage you contribute to eligible employees must be the same percentage as you contribute for yourself.

Because contributions to a SEP IRA are made by the business, participants 50 and older won't be able to make catch-up contributions.

Solo 401(k)s

Solo 401(k) plans are designed for one person and their spouse—if they also work for the business. You'll have the option to choose between traditional and Roth tax treatments.

How solo 401(k)s work

Solo 401(k) plans function as if you're two separate people—the employee and the employer. As the employee, you can contribute to the plan through salary deferrals, similar to an employer-sponsored 401(k). As the employer, you can make an additional profit-sharing contribution of up to 25% of net income as long as you don't exceed annual contribution limits.

Primary benefits of a solo 401(k)

• Solo 401(k) plans allow for large annual contributions, which may help you grow your retirement savings faster.
• If you're 50 or older, you may also be eligible for a catch-up contribution.
• You can borrow money from your solo 401(k) as long as you adhere to IRS guidelines for repayment.

Potential disadvantages

• Solo 401(k)s are designed for businesses with no employees other than the owner and their spouse.
• If you hire employees in the future, you may need to convert to another type of plan.
• With a few limited exceptions, you'll be hit with taxes and penalties if you withdraw funds from a solo 401(k) before you reach retirement age.
• Once your solo 401(k) has more than $250,000 in total assets, you'll have to file Form 5500-EZ annually with the IRS.

SIMPLE IRAs

Savings Incentive Match Plan for Employees IRAs, or SIMPLE IRAs, are commonly used by small businesses with up to 100 employees. Both the business and participating employees can make contributions, and contributions made by the business are fully tax-deductible.

How SIMPLE IRAs work

With a SIMPLE IRA, the business establishes an account for each eligible employee and makes required annual contributions into each account. As an employer, you'll have the choice between matching employee contributions up to 3% of a worker's pay and making a nonelective contribution of 2% of each eligible employee's compensation, regardless of whether the employee contributes.

Primary benefits of a SIMPLE IRA

• SIMPLE plans have fewer rules and may be easier to manage than other retirement plans for small businesses.
• During the first 2 years of participation, withdrawals and rollovers may be subject to additional restrictions and higher penalties. After this period, the same early withdrawal exceptions available to traditional IRAs generally apply.
• Employer contributions are tax-deductible, and tax credits may be available to eligible small businesses that meet certain criteria.
• Both employers and employees can contribute, and the SECURE Act 2.0 allows smaller businesses to offer higher contribution and matching limits—and in some cases, enhanced employer matching or nonelective contributions, depending on plan design.

Potential disadvantages

• If your business has employees, you'll be required to make annual contributions for all eligible employees.
• SIMPLE plans have lower annual contribution limits than other retirement plans for the self-employed, which may limit how much business owners can save.
• Withdrawals or rollovers within the first 2 years of plan participation may be subject to additional taxes and penalties.
• Employer contributions must follow one of two required formulas—either matching employee contributions or making a fixed percentage nonelective contribution—which may require more administrative coordination than some other plans.

Defined benefit plans

Defined benefit plans may be a good option for small business owners and individuals with extremely high self-employment income. They may also be ideal for those who need to save as much tax-deferred money as possible to catch up on retirement savings.

How defined benefit plans work

Defined benefit plans offer predictable income in retirement, and contributions are carefully managed to achieve this goal. Instead of relying on annual contribution limits set by the IRS, actuaries will calculate annual contributions based on the participant's age, compensation and length of employment.

Primary benefits of a defined benefit plan

• Higher annual contribution limits may allow participants to accumulate substantial retirement savings in a relatively short time.
• Compared to 401(k)s and other defined contribution plans, defined benefit plans ensure a more stable, predictable income in retirement.
• Loans may be permitted, depending on plan rules.

Potential disadvantages

• Defined benefit plans require use of an actuary to determine annual contributions, which is primarily why they can be expensive to set up and maintain.
• Annual filings with the IRS on Form 5500 are required.
• The business must make contributions for all eligible employees.
• Contributions are adjusted every year based on a variety of factors, which may require more funds than the business has available.
• Special taxes apply if participants don't meet the minimum contribution, which can be problematic in years when revenue and cash flow are lower.

The bottom line

Each of these retirement plans for the self-employed has specific advantages and disadvantages. The right option for you will largely depend on your current earnings, how much you want to contribute and whether you have any employees. A good first step is to speak with a financial professional for personalized advice so they can help you decide which self-employed retirement plan is right for you.