Retirement accounts are important for anyone who wants to retire someday. When you work for a big company or organization, you may have access to a 401(k), 403(b), 457, or similar retirement account, and perhaps an employer contribution. When you run your own solo business, retirement planning is on your shoulders.
But that’s not necessarily a bad thing. But that’s not necessarily a bad thing. Self-employed retirement accounts can amplify you retirement savings — and trim your tax bill. That’s a big win-win for your money. If you’re wondering what retirement options are available to you – and how they compare to employee-sponsored – accounts keep reading.
Retirement account contribution limits for employees
When you have a full-time job, you can take advantage of your employer’s 401(k) plan, or similar, as well as a traditional IRA or Roth IRA. The 2024 contribution limit for the employer-sponsored plans is $23,000 per year. Traditional and Roth IRA accounts have a $7,000 annual limit – $8,000 if you’re 50 years old or older. For most, the combined limit of these accounts is $30,000 – and most people save far less.
Traditional and Roth IRA accounts give you complete control when choosing your investment brokerage and investments. But keep in mind, employer-sponsored accounts typically have limited options and high fees. For example, TD Ameritrade says the typical all-in 401(k) fee is 0.45%, which is money taken from your retirement account that you won’t get to enjoy during your golden years.
Before-tax versus after-tax contributions
An employer-sponsored plan likely limits you to pre-tax contributions. Pre-tax contributions mean you don’t pay any taxes on the income the year of the contribution, but you do pay taxes on withdrawals in retirement. That lowers your taxes now and defers them until retirement – when your income is likely to be lower – and you’re subject to a lower tax rate.
When you use a Roth IRA or any other Roth-style retirement account, contributions are made after taxes. That means you’ll pay taxes on the income the year of the contribution, but qualified withdrawals in the future are tax-free, including capital gains. That’s why Roth accounts are usually better for younger people with a long-time horizon before retirement. Those nearing retirement may do a little better with a pre-tax account.
The difference in taxes here is tricky to estimate upfront because your income, tax rate, savings rate, investment returns, and retirement withdrawals will be different from anyone else’s. However, for people in their 20s, 30s, 40s, and even many in their 50s, a Roth-style account could be a better option.
When you’re self-employed, you can choose to use a Roth 401(k) – something that’s not available with many employer-sponsored plans. That gives you even more tax savings over time as your investments grow tax free.
Self-employed retirement options
Self employment gives you more options and autonomy. You can choose an account with no recurring fees, and virtually every single stock, bond, and fund should be available. These are the main types of accounts for self-employed solo entrepreneurs.
SEP IRA
A Simplified Employee Pension (SEP) IRA is arguably the easiest type of self-employed retirement account to set up. Your business contributes to this account on your behalf — lowering your business profits and taxable income. This is best for solo entrepreneurs, as companies must make equal contributions for employees, including owners.
You can contribute to an SEP IRA any time during the year without a regular schedule. For 2024, you can contribute up to $69,000, or 25% of your employee compensation up to $345,000, whichever is lower.
Solo 401(k)
A Solo 401(k) is a regular 401(k) plan, just with one employee. Many people like these Self-Directed 401(k) accounts more than SEP IRAs because they have the same $69,000 contribution limit, but you or your business can contribute. There’s also a workaround for the 25% compensation limit that SEP IRAs have. If you’re 50 or above, you can contribute an additional $7,500 “catch-up” contribution.
Solo 401(k) plans are usually fee-free and free to open. The accounts give you the same investment options as an SEP but take a little more paperwork to get started. If you have high ambitions for retirement savings, that extra paperwork is worth it.
SIMPLE IRA
The Savings Incentive Match Plan for Employees (SIMPLE) IRA may have simple in the name, but they’re likely less ideal than the two accounts above for a solo entrepreneur with an S Corp. If you do pick a SIMPLE IRA, contributions can be made by the business or employee (you).
SIMPLE accounts are funded through a combination of salary withholdings, employer matching, and nonelective contributions. Limits are lower than SEP and Solo 401(k) accounts, and there are more rules to worry about, so you’re probably better off with one of the accounts above.
Traditional IRA or Roth IRA
Even if you have an SEP IRA or a Solo 401(k) in place, you can pair it with a traditional IRA or Roth IRA. Whether you have a regular day job or your own solo business, it’s a good idea to hit the maximum contribution on this account every year – $7,000 for 2024 or $8,000 for ages 50 or older.
When you set up your own S Corp payroll to pay yourself, consider splitting your direct deposit so a portion goes directly to your IRA or setting up a recurring contribution on your payday schedule to hit the maximum limit here automatically.
Automate your retirement account savings
Just because you’re self-employed doesn’t mean you can’t automate your finances like people with a predictable salary. Use a payroll system to pay yourself for predictable paychecks and a completely automated retirement savings plan.
You can automate transfers from your business bank account to your retirement plan or use your personal checking account as a midway point. If you use a personal account, keep precise accounting records and maintain the corporate veil to keep your legal protections in place.
3x your retirement account balances
With an employer-sponsored retirement account, you can save up to $23,000 per year. With a Self-Directed 401(k), you can save a little more than 3x as much. But remember, your self-directed accounts won’t have any recurring fees, and you get more investment choices. You’ll probably do quite a bit better than 3x if you hit the maximum contribution limit on your accounts every year.
Saving $69,000 is a tall order — and many people will save a lot less. But if you can start with a recurring amount and add to the amount every year, you may be surprised by what’s possible. Particularly when you’re the business owner, not the employee, and get to keep all of the profits.
When you maximize your opportunities, you can set yourself on the path to your dream retirement.
