What to know about retirement if you're self-employed

Roughly 10 million people in the U.S. are self-employed, according to the Bureau of Labor Statistics.1 And while being your own boss can be fulfilling and lucrative, there's one perk of working for someone else that many self-employed people miss: having an employer-sponsored retirement plan.

The good news is that there are several retirement-saving options for self-employed people. Here's an overview of those options.

Traditional or Roth IRA

An individual retirement account (IRA) allows taxpayers with earned income (whether from self-employment or not) to save for retirement with tax-deferred or tax-free growth. There are two types of IRAs, each with different advantages.

• Traditional IRA. Contributions to a Traditional IRA are tax-deductible, and earnings in the account grow on a tax-deferred basis until withdrawn in retirement.
• Roth IRA. Contributions to a Roth IRA aren't tax-deductible, but earnings in the account are tax-free, and withdrawals are tax-free after age 59½ and the five-year rule has been met.2 (The five-year period begins the first tax year a contribution was made to your Roth IRA.)

For tax year 2022, the combined maximum contribution to a Traditional or Roth IRA is $6,0003 ($7,000 for individuals aged 50 or older). The deadline for making contributions is the tax filing deadline, not including extensions, meaning contributions for the 2022 tax year can be made up to April 17, 2023.

Traditional and Roth IRAs are good for self-employed people with no employees who want to start saving for retirement.

Self-Employed Retirement Options

While self-employed people don't get access to employer-based retirement plans, there are three other retirement options (in addition to Traditional and Roth IRAs) to consider.

SEP IRA

A simplified employee pension (SEP) IRA is a retirement plan for both solopreneurs and businesses with few employees.

While there's no set limit to the number of employees that can participate in a SEP IRA, it's usually best for companies with very few employees because business owners must contribute equally to their own SEP IRA and those of their eligible employees.

The employer funds contributions to the plan.

For tax year 2022, the maximum contribution to a SEP IRA4 is the lesser of:

• 25% of net earnings from self-employment, or
• $61,000

If the business owner contributes to their plan, they need to contribute the same percentage of earnings to their employees' accounts. The deadline for making SEP IRA contributions5 is when you file your tax return, assuming you meet the deadline (including extensions) for filing a federal income tax return for that year. This is October 16, 2023 for 2022 contributions and October 17, 2022 for 2021 contributions.

This is why SEP IRAs are good for solopreneurs or those with few employees.

Individual 401(k)

An individual 401(k), also known as a solo 401(k), is designed for self-employed business owners with no full-time employees (other than a spouse who works full-time for the business).

With an individual 401(k), contributions come from both the individual and the business.

For tax year 2022, the maximum contribution to an individual 401(k) is $61,0006 ($67,500 for individuals age 50 or older). That total includes:

• Employee salary deferral: Up to $20,500 ($27,000 for individuals ages 50 or older), plus
• Employer contributions: Up to 25% of compensation

For example, say you are a 45-year-old single-owner corporation with no employees. Your W-2 wages from the business are $100,000. For 2022, your maximum solo 401(k) contribution would be $45,500. That consists of:

• The maximum employee elective deferral of $20,500, plus
• An employer contribution of $25,000 (25% of your $100,000 of W-2 income)

If you were over the age of 50, you would be able to contribute an extra $6,500. In any event, your plan contributions can't be more than your income for the year.

The calculation can vary depending on your income, age, and whether your business is incorporated. A Solo 401(k) Contributions Calculator7 like the one available from AARP can help you calculate your maximum contribution.

The deadline to contribute to a solo 401(k) is the filing deadline of the business's tax return, not including extensions. So the deadline is generally March 15 or April 15, depending on how your business is structured.

Individual 401(k)s are good for self-employed people with no employees who want to make significant contributions. However, these plans require owners to file a tax return for the plan (Form 5500-EZ)8 if plan assets exceed $250,000.

For each tax year, you can contribute to both a SEP IRA and an Individual 401(k), but you cannot contribute more than the annual limit—$61,000 or 25% of compensation—to both plans combined.9