How to plan for retirement when you’re self-employed

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Many people dream of being self-employed, setting their own hours, and making more money. However, one of the biggest retirement money mistakes made by the self-employed is, well, not actually setting aside money for the future.

It can be hard to remember to save for retirement when you don’t have an employer providing a plan on your behalf. The good news is you still have options if you need a retirement plan as a freelancer, sole proprietor, or small business owner.

Here are the details on six different self-employed retirement plan options so you can decide which might be a smart fit for your personal goals.



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Traditional or Roth IRA

  • Annual contribution limit: For 2021, $6,000 (plus $1,000 catch-up contribution if you’re at least 50)
  • Tax treatment: Tax deduction (traditional) or after-tax dollars (Roth)
  • Who it’s best for: Self-employed or small business owners who want something easy to manage and don’t feel ready to make bigger contributions.

How it works

An individual retirement account (IRA) is designed to allow you to make tax-advantaged investments without the need for an employer-sponsored plan. Generally, you have two choices when it comes to the IRA types you could open:

  • Traditional: Receive a tax deduction for contributions to your traditional IRA today. Your money grows tax-deferred. When you withdraw from your account, you pay taxes at your marginal tax rate. There are income phase-outs for claiming the tax deduction, however, so higher earners may not be able to get the most advantage from traditional IRAs.
  • Roth: Roth IRAs also have income thresholds, but if you qualify by making less than a certain amount of money each year, you can make contributions with after-tax dollars. Your money grows tax-free and when you withdraw, you don’t have to pay taxes on the amount.

It’s important to note that you can contribute to both a traditional and a Roth IRA, but your combined contribution amounts can’t exceed the annual limit based on your income.

Carefully consider your expected tax situation. If you think your taxes will be lower in the future, it could make sense to use a traditional IRA and take advantage of today’s tax deduction. On the other hand, if you think your taxes will be higher during retirement, then paying taxes on your contribution dollars now so you don’t have to pay them when you withdraw could be a smarter move. That would mean a Roth could be the way to go.

With either type of IRA, you can choose to begin taking penalty-free withdrawals at age 59 1/2, though there are some exceptions.

Finally, consider that when you reach age 72, you’ll be stuck with required minimum distributions if you have a traditional IRA, and that can change your tax situation. There are no RMDs with a Roth IRA.

How to get started: Many traditional and online brokers, as well as robo-advisors, offer traditional and Roth IRA accounts that allow you to start investing money for retirement. Look for an account that doesn’t have a minimum balance requirement and create an automatic investment plan designed to help you save without thinking about it.

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Solo 401(k)

  • Annual contribution limit: For 2021, $19,500 or up to $58,000 ($6,500 catch-up contribution available for those 50 and older)
  • Tax treatment: Tax deduction (Traditional) or after-tax dollars (Roth)
  • Who it’s best for: Business owners who want to be able to make larger contributions to retirement and are not planning on adding more employees.

How it works

If you’re self-employed, you can open a solo 401(k) for you (and your spouse) and save for retirement. Sometimes, this small business retirement plan is also called an individual 401(k), a uni-401(k), or a one-participant 401(k) plan.

One of the benefits of using the solo 401(k) is that you can make contributions as both an employee and as an employer. With a regular 401(k), employees can contribute up to $19,500 and you can also receive employer contributions, up to a total of $58,000 per year, depending on your salary. With a solo 401(k), it’s possible for you to play both roles and take advantage of this higher contribution limit.

When it’s just you (and possibly your spouse) participating in the plan, you don’t have to worry about IRS discrimination testing. However, realize that if you end up hiring employees, you will then need to provide them with a 401(k) plan and meet IRS regulations. Administering a 401(k) plan as a small business can be burdensome, so it might make sense to look into other plans if you think you’ll hire employees beyond your spouse.

As with many other tax-advantaged retirement plans, you’ll pay an early withdrawal penalty if you take distributions before age 59 1/2, except in certain circumstances.

Finally, it’s possible to set up a Roth version of a 401(k). The tax considerations are the same as what you’d see with a traditional vs. Roth IRA, but it’s important to note that a Roth solo 401(k) comes with RMDs starting at age 72.

How to get started: Finding an administrator to handle your solo 401(k) can be a little more difficult than opening an IRA. You might need to speak with a traditional broker, like Fidelity or TD Ameritrade (a subsidiary of Schwab) in order to set up a solo 401(k). Some robo-advisors, like Betterment, also offer 401(k) services, but they might not be set up for solo 401(k) accounts.

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  • Annual contribution limit: For 2021, up to 25% of compensation or $58,000, whichever is lower
  • Tax treatment: Tax-deductible (no Roth option)
  • Who it’s best for: Self-employed individuals who want to save more than with a “regular” IRA or those who want to provide employee benefits.

How it works

If you have a SEP IRA, you might be able to set aside more for retirement than you could with a traditional or Roth IRA. SEP stands for “simplified employee pension” and the contribution limits are higher, which allows you to invest a percentage of your compensation for retirement and do so in a tax-advantaged manner.

This is also one of the easiest plans to implement if you have employees and want to provide them with a retirement benefit. However, if you do use a SEP IRA for your employees, you have to contribute the same percentage of income to everyone’s account. So if you’re contributing 2% of your income to your SEP IRA, you have to contribute the same percentage to your employees. Note that employees themselves don’t make contributions to their SEP IRAs. As the employer, you fully fund their accounts.

As with other tax-advantaged self-employment retirement plan options, you’re expected to keep the money in your account until you reach age 59 1/2, unless you qualify for certain exceptions. Additionally, the SEP IRA comes with RMDs when you reach age 72.

How to get started: Most traditional brokerages will allow you to set up a SEP IRA. There are also robo-advisors like Wealthfront and Acorns that offer these accounts. Once you get set up, you can begin making recurring contributions to build your nest egg.

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  • Annual contribution limit: For 2021, up to $13,500 ($3,000 catch-up contribution available for those 50 and older)
  • Tax treatment: Tax deduction (no Roth option)
  • Who it’s best for: Business owner who wants to provide employee benefits without the need for a nondiscrimination test.

How it works

SIMPLE stands for “savings incentive match plan for employees.” A SIMPLE IRA makes an attractive retirement plan for self-employed business owners because it’s easy to set up and administer. Additionally, the SIMPLE IRA isn’t subject to IRS nondiscrimination rules.

However, it’s important to note that the SIMPLE IRA comes with the requirement that an employer fund the retirement account. There are two main options for contributing to employee SIMPLE IRAs:

  • Automatically contribute 2% of the employee’s salary to the account, regardless of how much they contribute.
  • Match employee contributions dollar for dollar on up to 3% of the employee’s salary. It’s possible to reduce the 3% down to 1% of salary temporarily, but it can’t be done in more than two calendar years out of five.

For tax purposes, a SIMPLE IRA functions like a traditional IRA, with pre-tax dollars decreasing taxable income now and requiring you to pay taxes when you take distributions. This is another account that levies a 10% penalty if you withdraw before age 59 1/2, unless you meet certain criteria. Additionally, RMDs are part of the SIMPLE IRA.

How to get started: As with many other retirement plans, you need to find an administrator to help you manage the SIMPLE IRA. Many of the major traditional brokerages can help you establish and administer a SIMPLE IRA for you and your eligible employees.

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Health Savings Account

  • Annual contribution limit: For 2021, $3,600 (individual) or $7,200 (family), ($1,000 catch-up contribution available for those 55 and older)
  • Tax treatment: Tax-deductible contributions, tax-free withdrawals for qualified expenses
  • Who it’s best for: Those who want to save tax-free money for qualified health care expenses and supplement their retirement savings.

How it works

A health savings account is a way to use tax-free money to save for qualified medical expenses. In order to use an HSA, you need to be on a high-deductible health plan. If you’re self-employed, there’s a good chance you can get a high-deductible health plan by purchasing your insurance on an Affordable Care Act exchange. This then qualifies you to open an HSA. Often employer-sponsored health plans have the option of choosing a high-deductible option as well.

You can decide to contribute to an account, and then withdraw money at any time, without penalty, as long as the money is used for qualified medical expenses. These expenses can include copays, prescriptions, over-the-counter medications, eye and dental care, various medical procedures, and more. If you use the money from your HSA for something that isn’t qualified, you will pay a 20% penalty on top of paying income tax on the amount withdrawn.

It might also be possible to invest money held in your HSA into the stock market, mutual funds, or other securities and let it grow over time. You could then use the money in your account to help pay for health care costs during retirement and never have to pay taxes on the money.

Another option is to use the HSA as a backup IRA. When you reach age 65, you can withdraw funds from your account without paying the penalty, but you’re still responsible for paying the applicable income tax.

How to get started: Many banks, financial institutions, and brokerages offer HSAs. However, not all HSA providers offer investment options, or you might have to wait until your account reaches a certain threshold before you can begin investing. There are HSA providers, like Lively, that allow you to set up an account and connect it to an investment account to easily manage and grow your portfolio.

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Defined benefit plan

  • Annual contribution limit: Based on your desired annual benefit, for 2021, the maximum annual benefit is $230,000.
  • Tax treatment: Tax-deductible contributions
  • Who it’s best for: Those who want to have a defined benefit, similar to a pension, after they’re done working.

How it works

A defined benefit plan is one in which you receive a set annual benefit when you retire. You’re allowed to set up a defined benefit retirement plan as a self-employed person, but you need to have an actuary perform a calculation to determine how much you need to contribute in order to reach your desired benefit.

Your contribution will be based on your age, years of services, potential investment returns, and other factors. Later, when you retire, you begin receiving your pension payout in the amount agreed upon.

How to get started: There aren’t a lot of brokers or banks that are willing to manage a defined benefit retirement plan for the self-employed. However, Charles Schwab is one of the brokers that will provide this type of service on your behalf.

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How to pick a self-employed retirement plan

When choosing a self-employed retirement plan, it’s important to carefully consider your situation and what will likely make the most sense for you. The smartest self-employed retirement account will reflect your circumstances and help you reach your long-term financial goals.

Some of the things to consider when choosing from among your self-employed retirement plan options include:

  • Taxes: Consider your tax strategy and how this account could play into your tax planning. Are you more interested in reducing your taxes today, or do you want tax-free distributions later?
  • Simplicity: Think about whether you want to deal with a lot of restrictions, or whether you want something that’s easy to manage. Traditional and Roth IRAs, as well as SEP IRAs, are some of the easiest accounts to manage if you don’t have employees.
  • Employees: If you want to provide a retirement benefit for your employees, SEP and SIMPLE IRAs are among the easiest accounts to manage, and a SIMPLE IRA can provide a level of flexibility. Consider your business plan when choosing your retirement plan as some will be better for those with fewer employees.
  • Contributions: Use a retirement calculator to determine how much you need to set aside each year in order to meet your goals. Depending on your situation, a traditional or Roth IRA might not allow you to make big enough contributions to grow your nest egg to the right size.
  • Income requirements: If you want a fixed income in retirement, a defined benefit plan might make sense. Most of the other plans are defined contribution plans, and you can’t control how much income you actually receive in retirement. A defined benefit plan, though, allows you to set your desired level of income during retirement so you have a little more certainty.

Don’t forget that it’s possible to include an HSA in your retirement planning. When you choose a tax-advantaged retirement plan for your self-employed status, you can also contribute to an HSA if you qualify. This can provide you with a way to supplement your retirement by saving up for health care costs, and then you can use distributions from your IRA or 401(k) to cover regular non-medical expenses. Plus, your HSA can act as a backup IRA once you reach age 65.

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What is the best retirement plan for a self-employed person?

The best retirement plan for a self-employed person is the one that meets your needs. Consider your tax strategy, income needs, and contribution limits. Look for a plan that will allow you to set aside enough money each year to potentially grow your nest egg while helping you maximize your tax efficiency. Don’t forget to consider the requirements for contributions if you have employees.

Can you have a 401(k) if you are self-employed?

If you’re self-employed, you can open a solo 401(k) and make contributions. However, you can’t use a solo 401(k) if you have other employees other than your spouse. Instead, you’d have to set up an IRS-approved program to provide retirement benefits to the rest of your employees.

What is the difference between a SEP and a SIMPLE retirement plan?

The main difference between a SEP and a SIMPLE retirement plan lies in who makes contributions to the plan. With a SEP, the employer makes contributions to their own plan, as well as to the plans of the employees. There is no way for employees to make their own contributions to a SEP IRA. A SIMPLE IRA, on the other hand, allows for a situation in which employees can make their own contributions, with the employer matching contributions.

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Bottom line

Even if you’re self-employed and you don’t have access to a retirement plan provided by a company, it’s important to start saving for retirement. There are a number of retirement plans for the self-employed, and some of the best brokerage accounts and best investment apps could provide you with access to these types of plans.

Carefully consider your situation, the state of your self-employment income, and your future needs, and then choose a plan that works for you. If you still have questions or you feel your situation is more complex, consider making an appointment to speak with a financial advisor.

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