Self-employment has become an increasingly popular lifestyle choice in the U.S.: The Bureau of Labor Statistics estimates that in 2015, just over 10% of the working population was self-employed. Fortunately, retirement savings options for independent contractors and small businesses have grown to include some extremely appealing choices.
Simplified Employee Pension (SEP) plans are usually the best choice for small business owners who don't have employees. SEP-IRA accounts are easy to set up and have low or no account fees and extremely flexible contribution rules. If you don't have employees you can contribute as little or as much as you want to your SEP-IRA, up to a maximum of 25% of your total compensation or $54,000 (in 2017), whichever is lower. And you can make your contributions at any time during the year.
If you have employees, you can still have a SEP plan -- but contribution rules get a bit more complicated. Basically, if you contribute to one SEP-IRA (including your own) you have to make equivalent contributions to every other employee's SEP-IRA. You can set certain requirements as to which employees are eligible to have SEP-IRA accounts: Typically, an employee must have worked for you for a certain number of years, must be a certain age, and must have earned a minimum amount.
Another option for solopreneurs is the individual 401(k) (sometimes also called the self-employed 401(k)). To open an individual 401(k), you can't have any non-owner employees. It's best to stay away from this type of retirement savings account if you think you'll likely have employees in the future, since adding non-owner employees to your business will require you to completely restructure your 401(k) plan in a complicated and often expensive manner.
Individual 401(k)s have the most generous contribution limits of all the small business retirement accounts because you can make contributions as both an employee and as an employer. As an employee, the contribution limits are the same as for any 401(k): In 2017, the limit is $18,000 per year, or $24,000 per year if you're 50 or older -- not to exceed your compensation for the year. In addition, as an employer you can contribute up to 25% of your compensation for the year. For the purposes of this calculation, your compensation is your earnings minus one half your self-employment tax and minus any contributions you made as an employee.
Like SEP-IRA plans, individual 401(k)s are simple to set up and cheap to maintain. However, once you have over $250,000 saved in your 401(k), you must file Form 5500 annually with the IRS. You can't withdraw funds from your individual 401(k) unless a "trigger" event happens (trigger events include closing the business, terminating the 401(k) plan, or reaching age 59 1/2).
The best choice for small business owners with employees, a SIMPLE IRA plan is an option for any small business with 100 or fewer employees. SIMPLE IRAs are fairly easy to set up. You need only find a bank or brokerage to act as the plan trustee and fill out one of the IRS SIMPLE IRA template documents. SIMPLE IRAs usually have low or no account maintenance fees.
With a SIMPLE IRA plan, you're required to make contributions every year. You can choose one of two contribution systems: either a 3% matching contribution, or a 2% contribution regardless of whether or not the employee contributed to the account themself. You can't contribute more than that as an employer, although you can contribute as an employee to your own account -- up to $12,500 (in 2017) or $15,500 if you're age 50 or older, not to exceed your total compensation. Whichever system you choose, you're required to apply it to each and every account.
Why set up an employer plan?
You may be wondering why you shouldn't just stick with a basic IRA, which is a whole lot simpler to set up and maintain than the above options. The answer is simple: IRA contribution limits are too low for you to save enough money to retire comfortably. The IRA contribution limit for 2017 is $5,500, or $6,500 if you're 50 or older. Most workers will need to save at least 10% of their income, although 15% or more is a better goal. But once you are earning more than $55,000 per year, you won't be able to hit even a 10% contribution rate using just an IRA. So by all means, open an IRA (or even better, a Roth IRA) to complement your employer retirement savings account -- but don't limit yourself to the extremely low savings rate that a basic IRA requires.
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