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Retirement

Retirement Plan Options For Business Owners & The Self-Employed

Self-employed individuals and business owners have access to a wide variety of retirement plan options. There are five different retirement accounts you can choose from.

  1. Solo 401k
  2. SEP IRA
  3. Traditional IRA
  4. Roth IRA
  5. SIMPLE IRA

Each type of plan has different eligibility rules, contribution limits, and tax treatments.

Account Contribution Limits Roth Pros Cons
Solo 401k $61,000 ($67,500 if age 50+) in 2022. $66,000 ($73,500 if age 50+) in 2023. Yes Full control over investments, highest contribution limits, Roth option. Not allowed to have full-time employees.
SEP IRA $61,000 in 2022. $66,000 in 2023. No High contribution limits. No Roth option, and only employers can contribute.
Roth IRA $6,000 ($7,000 if age 50+) in 2022. $6,500 ($7,500 if age 50+) in 2023. Yes Withdrawals in retirement are tax-free, contributions can be withdrawn at anytime, no RMD. Small contribution limit.
Traditional IRA $6,000 ($7,000 if age 50+) in 2022. $6,500 ($7,500 if age 50+) in 2023. No Contributions are tax-deductible. Small contribution limit. High income earners cannot contribute.
SIMPLE IRA $14,000 ($17,000 if age 50+) in 2022. $15,500 ($19,000 if age 50+) in 2023. No Simple, cost-effective option for offering a retirement plan to employees. Contributions are tax-deductible. No Roth option, contribution limits are lower than a 401k.

Let's go through each account in more detail.

The Solo 401k

The solo 401k is the best overall retirement plan for business owners and self-employed people. You can think of it as a supercharged hybrid of a traditional company 401k plan and a Roth IRA. However, to qualify for a solo 401k, you must have no full-time employees that work over 1,000 hours per year in your business.

A solo 401k can accept rollovers from any type of retirement plan, except a Roth IRA, has the highest contribution limits, a Roth option, full investment freedom, and the ability to double your household contribution limits if you add your spouse.

How it works

A solo 401k is like a traditional company 401k except that you have full control over it. As the business owner, you get to decide your income and how much you contribute as both the employer and the employee. You also have freedom to invest in what you want, compared to a regular 401k plan, where you're limited to around a dozen mutual fund selections.

Eligibility: Who is it for?

The best candidates for a solo 401k are:

  • Self employed individuals or business owners with no employees.
  • Someone with a regular day job, but also has a side hustle.

To be eligible for a solo 401k, you must have self-employment activity (basically earning any amount of income from your business qualifies you for this), and must not have any full-time employees that work over 1,000 hours per year in your business (other than your spouse).

Contribution limits

The contribution limit for a solo 401k is $61,000 ($67,500 if age 50+) in 2022 and $66,000 ($73,500 if age 50+) in 2023. Because you’re the owner of your business, you get to contribute as both the employer and the employee.

  • As an employee, you can contribute up to 100% of your compensation up to a maximum of $20,500 in 2022 and $22,500 in 2023. If you’re over the age of 50, your employee deferral limit is $27,000 in 2022 and $30,000 in 2023.
  • As an employer, you can also contribute up to 25% of your compensation if your business is incorporated, and up to 20% if your business is not incorporated.

Benefits & tax advantages

The benefits and tax-advantages of a solo 401k are unmatched by other retirement plans. It comes with the highest contribution limits, full investment freedom, and a Roth option. You can deposit all your employee deferrals into a Roth account, bringing your total Roth contribution limit to $20,500 ($27,000 if age 50+) in 2022 and $22,500 ($30,000 if age 50+) in 2023. There are no income limits – you qualify whether you make $100 per month or $100,000 per month – and all business entities are eligible as long as they have no employees.

Disadvantages

The only disadvantages with a solo 401k is that you can't hire any full-time employees. This doesn't affect everybody, since many business owners don't have plans to hire anyone full-time.

When can you withdraw your money?

You can start taking qualified distributions from your solo 401k once you reach the age of 59½. You're also required by the IRS to start taking required minimum distributions (RMD) starting at the age of 72. Early withdrawals before the age of 59½ are subject to 10% fees plus income taxes on the amount drawn.

SEP IRA

With a solo 401k, you're not allowed to have any full-time employees. If you do end up hiring a full-time employee, it may be time to start looking into opening a SEP IRA, which is designed for business owners with zero or just a handful of employees.

The next best retirement plan for business owners is the SEP IRA. It's a similar plan to a solo 401k, but you don't get a Roth option, and only employer compensation can be contributed to the plan.

Eligibility: Who is it for?

The best candidates for a SEP IRA are:

  • Employers who used to have a solo 401k, but have hired a full-time employee.
  • Employers who want to offer a retirement plan to their employees, but want a simpler, more cost-effective option than something like a traditional 401k plan.

Any business owner is eligible to open a SEP IRA. It's most recommended for business owners with few employees, since employers must make equal percentage contributions for every eligible employee in your business. A SEP IRA can be a cost-effective way to offer a retirement plan for your employees. It's easier to set up and can be cheaper than offering your employees a traditional 401k retirement plan.

Contribution limits

The contribution limit for a SEP IRA is $61,000 in 2022 and $66,000 in 2023. The contribution limit is the same as a solo 401k, but you can only make contributions with employer compensation. You are not allowed to make employee deferrals into a SEP IRA, and there are no catch-up contributions for people ages 50 and above.

  • You can contribute up to 25% of your compensation.

If you have full-time employees, you're obligated to make equal percentage contributions to their SEP IRA accounts as well.

If you contribute to your SEP IRA, you're required to also contribute to an employee's SEP IRA up to 25% of compensation for both sides.

For example, if you contribute 25% of your compensation into a SEP IRA, you also need to contribute 25% of every employee's compensation into their SEP IRAs. If you contribute just 5% into your account, you'll also need to contribute 5% of every employee's compensation as well. This is the reason why a SEP IRA can get expensive if you have many employees.

Note: Employees cannot make contributions to a SEP IRA on their own. All contributions to employee SEP IRAs are made through equal percentage employer contributions.

Benefits & tax advantages

The SEP IRA has the highest contribution limits, equal to that of the solo 401k. While there's no Roth option available, all your contributions are deductible from your taxable income each year. Opening a SEP IRA is also extremely simple, and if you have just a handful of employees, it could be a much more cost-effective way to offer them a retirement plan than a regular 401k.

Disadvantages

While you're allowed to hire employees with a SEP IRA, it also means that you have to make matching contributions to their accounts any time you contribute to yours. Additionally, there is no Roth option or catch-up contributions with a SEP IRA.

When can you withdraw the money?

You can start making withdrawals from your account once you turn 59½ years old. You're also required to start taking required minimum distributions at the age of 72. Early withdrawals before you turn 59½ will be taxed as regular income, on top of a 10% fee on the drawn amount.

Traditional IRA & Roth IRA

Traditional and Roth IRAs are like the starter plans of retirement accounts for any individual with earned income. The contribution limits are much lower than a solo 401k or a SEP IRA.

Eligibility: Who is it for?

Anyone with earned income is eligible for a traditional IRA and Roth IRA. There are no age limits.

Income limits

A traditional IRA doesn't have income limits; any income level is eligible. However, the amount you can deduct in taxes is based on income levels.

  • In 2022, if your income is $68,000 or less, you get a full deduction.
  • In 2023, if your income is $73,000 or less, you get a full deduction.
  • In 2022, if your income is more than $68,000 but less than $78,000, you get a partial deduction.
  • In 2023, if your income is more than $73,000 but less than $83,000, you get a partial deduction.
  • In 2022, if your income is more than $78,000, you get no deduction.
  • In 2023, if your income is more than $83,000, you get no deduction.

A Roth IRA has income limits.

  • In 2022, if your income is $129,000 or less, you can contribute up to the maximum amount.
  • In 2023, if your income is $138,000 or less, you can contribute up to the maximum amount.
  • In 2022, if your income is more than $129,000 but less than $144,000, your contribution limit is reduced.
  • In 2023, if your income is more than $138,000 but less than $153,000, your contribution limit is reduced.
  • In 2022, if your income is more than $144,000, you cannot contribute to a Roth IRA.
  • In 2023, if your income is more than $153,000, you cannot contribute to a Roth IRA.

Contribution limits

The contribution limits for a traditional IRA and a Roth IRA are the same: $6,000 ($7,000 if age 50+) in 2022 and $6,500 ($7,500 if age 50+) in 2023.

Contribution types are different for a traditional IRA and a Roth IRA, and it's the main differentiator between the two accounts.

  • Traditional IRAs are funded with pre-tax dollars. Contributions are tax-deductible, but distributions in retirement are taxed as regular income.
  • Roth IRAs are funded with post-tax dollars. You pay income tax on your contributions today, but distributions in retirement are tax-free.

Benefits & tax advantages

Your tax advantage depends on if you have a traditional IRA or a Roth IRA.

  • The benefit of a traditional IRA is that you get tax savings today. Contributions are deducted from your taxable income.
  • The benefit of a Roth IRA is that, even though you contribute with after-tax dollars, you owe zero taxes in retirement.

Disadvantages

The disadvantages of a traditional IRA is that your contribution limits are much lower than other retirement plans. Your tax deductions are also restricted by your income levels.

The disadvantages of a Roth IRA is that high income earners cannot participate at all. And even if you're eligible, contribution limits are much lower than other retirement plans.

When can you withdraw the money?

For both the traditional IRA and Roth IRA, you're allowed to start taking qualified distributions from your account when you reach the age of 59½. Early distributions are subject to a 10% penalty fee plus income taxes on the amount drawn.

However, the rules are slightly different for a Roth IRA.

  • The Roth IRA has a 5-year rule. Even if you’re over the age of 59½ you must have held your account for at least 5 years before you can start withdrawing earnings from your account.
  • However, with a Roth IRA, you’re allowed to withdraw only your contributions from your account at any time without penalty or taxes, even if you’re under the age of 59½.

For example, if you contributed $20,000 into a Roth IRA over the years, and earned interest of $5,000, your total account value is $25,000. You’re allowed to withdraw your contributions of $20,000 at any time. You must wait until you’re over the age of 59½ AND your Roth IRA must be at least 5 years old for you to withdraw the $5,000 in earnings.

Required Minimum Distributions (RMD)

A traditional IRA has RMD rules and you're obligated to start making withdrawals from your account when you reach the age of 72. A Roth IRA has no RMD and you can keep the money in your account for as long as you want. Having no RMD also makes a Roth IRA a suitable vehicle to pass down money to your beneficiaries.

SIMPLE IRA

A SIMPLE IRA is best for employees since the main purpose of this account is not to fund your own retirement plan, but to provide a retirement plan for your employees.

With a SEP IRA, you make contributions to your own account, and make equal percentage contributions to your employees' accounts. Because contribution limits are so high, it can still make sense to have a SEP IRA even if you have no employees.

With a SIMPLE IRA, you're obligated to make contributions to employee accounts even if you don't contribute to your own account.

Its main use is as a cheaper, simpler alternative to a traditional company 401k plan, which requires more paperwork, more administration, and more money to offer. Like a 401k, employees can make contributions to their own plans, but the contribution limits are smaller than a regular 401k plan.

How it works

When you set up a SIMPLE IRA at your company, you're required to make mandatory contributions to your employees' SIMPLE IRAs.

Employers must choose from one of two contribution options:

  1. Match an employee's contributions dollar-for-dollar up to 3% of their salary without any salary limits.
  2. Make non-elective contributions equal to 2% of an employee's salary up to a maximum salary limit of $305,000.

Eligibility: Who is it for?

The perfect candidate for a SIMPLE IRA is:

  • Business owners who want to offer a retirement plan for their employees, but want a cheaper, easier-to-administer option than a typical 401k plan.

To be eligible for a SIMPLE IRA, you must be a business owner with under 100 employees that make at least $5,000 per year. You can open a SIMPLE IRA as a business owner even if you have zero employees. However, that also makes you eligible for a solo 401k and a SEP IRA, which are better options for eligible self-employed people.

Employee eligibility

  • With a 401k, employees who are at least 21 years old and have worked at least 1,000 in the last year are eligible to be included in the plan.
  • With a SIMPLE IRA, any employee who made at least $5,000 in any of the previous two years, and are expected to earn at least $5,000 in the current year are eligible to be included in your plan.

Contribution limits

The contribution limit for a SIMPLE IRA is $14,000 ($17,000 if age 50+) in 2022 and $15,500 ($19,000 if age 50+) in 2023. Employer contributions are immediately vested - employees have full ownership of the money once an employer contributes to their accounts.

For employers, contributions made to employees' SIMPLE IRAs are tax-deductible from your business income.

Benefits & tax advantages

A SIMPLE IRA is a cost-effective, simple way to offer a retirement plan to your employees without having to offer a full-fledged 401k plan. Employers are obligated to make mandatory contributions towards employees' accounts, but contributions are tax-deductible for employers. Setting up a SIMPLE IRA is also much simpler than a general 401k plan, and requires less annual administration and maintenance.

Disadvantages

The disadvantages of a SIMPLE IRA are that it has a much lower contribution limit than something like a traditional 401k and no Roth option. The mandatory contributions could also be a burden for some business owners, especially if you have dozens of employees.

When can you withdraw the money?

Employees can start taking qualified distributions from their accounts once they reach the age of 59½. Early withdrawals get hit with a 10% fee plus income taxes on the amount drawn.

Summary

1. Solo 401k

  • Best overall retirement plan for business owners and self-employed individuals.
  • Benefits include: Highest contribution limits, Roth option, full investment freedom.
  • Must not have any full-time employees that work over 1,000 hours per year, excluding your spouse.

2. SEP IRA

  • Next best option after the solo 401k if you start hiring full-time employees.
  • Same contribution limits as a solo 401k, but you don't have a Roth option.
  • Contributions can only be made with employer compensation (contributions are calculated with 25% of compensation).
  • Good option for business owners with few employees, since equal percentage contributions must be made for every employee in your business. (Ex. If you contribute 10% of your compensation, you must also contribute 10% of every employees' compensation into their SEP IRAs.

3. Traditional IRA & Roth IRA

  • Much lower contribution limits.
  • With a traditional IRA, you contribute with pre-tax dollars, get a tax-deduction, but withdrawals in retirement are taxed as regular income.
  • With a Roth IRA, you contribute with after-tax dollars, get no tax-deduction, but withdrawals in retirement are tax-free.
  • Anybody with taxable income is eligible to contribute.
  • High income earners cannot contribute to a Roth IRA.

4. SIMPLE IRA

  • A low-cost, simpler alternative for offering a retirement plan to your employees compared to something like a 401k.
  • Employers must make mandatory annual contributions towards employees' SIMPLE IRAs.
  • Cheaper and simpler to set up than a company 401k, but has lower contribution limits.
  • Employer contributions are tax-deductible from business income.

Conclusion

There are five retirement plan options for business owners and self-employed individuals.

The solo 401k is the best overall option. It gives you the most contribution room, you get to choose whether you contribute in pre-tax or Roth, and full investment freedom. The downside is that you can't have any full-time employees that work over 1,000 hours per year in your business (excluding your spouse).

If you do hire your first full-time employees, the next best option is the SEP IRA. The SEP IRA allows you to have up to 100 employees. It has the same contribution limits as a solo 401k, but you don't get a Roth option and all contributions must be made with employer compensation only. If you contribute to your SEP IRA, you're also required to make equal percentage contributions to every employee in your business. If you have many employees, it can get expensive and a SIMPLE IRA might be the better option.

Both the traditional and Roth IRA are great accounts in functionality and tax treatment, but have much lower contribution limits than the solo 401k and SEP IRA. The Roth IRA also has an income limit, preventing high income earners from contributing to an account.

A SIMPLE IRA is like a budget 401k plan. It's cheaper and simpler to set up than a 401k, but still allows you to offer a retirement plan for your employees. Unlike the other accounts mentioned in this list, a SIMPLE IRA is mainly for providing a retirement plan for your employees, rather than saving for your own retirement.

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