Being your own boss certainly has its perks. You can set your own hours and your own goals. But many freelancers and small-business owners may feel like the trade-off is not having access to a workplace retirement plan such as a 401(k).
The truth is, you have plenty of options. So I'm going to walk you through these to help you choose one that's right for you. Here's what we'll be covering.
- Individual Retirement Account (IRA)
- Roth IRA
- Solo 401(k)
- SEP IRA
- SIMPLE IRA
You can easily open these accounts online through most financial institutions.
Traditional IRA
A traditional IRA offers many of the same benefits as a traditional 401(k). It's funded with pre-tax dollars, so contributions can lower your tax bill. But unlike with 401(k) plans, you won't be limited to an investment menu set by the plan sponsor. A traditional IRA and other plans we'll cover let you invest in virtually any kind of security, including stocks, bonds, exchange-traded funds (ETFs), mutual funds, and alternative assets.
But one major point to consider about the plans we'll explore is that you'd be penalized for taking withdrawals before age 59.5 in most cases. And unlike Roth IRAs, traditional IRAs require you to begin making withdrawals at age 72. Because of the way traditional IRA tax benefits work, this option may be best for freelancers who expect to retire in a lower income tax bracket than they are in now.
Traditional IRA tax benefits: Contributions to traditional IRAs are tax-deductible and can thus lower your tax bill for the year you contribute. Your earnings in the account grow tax free. But qualified withdrawals are taxed at your ordinary income tax rate once you reach age 59.5.
Contribution limits: $6,000 ($7,000 if you're age 50 or older) in 2022.
Roth IRA
A Roth IRA won't allow you to make tax-deductible contributions, but qualified withdrawals are tax-free as long as you're at least 59.5 years old and you've been contributing to it for at least five years. Unlike with a traditional IRA, you can withdraw your own contributions penalty-and-tax-free anytime. However, if you withdraw earnings without meeting the rules, you can owe a 10% penalty in addition to ordinary income tax on those earnings.
Also, not everyone can contribute to a Roth IRA. To make a full contribution to a Roth IRA in tax year 2022, your Modified Adjusted Gross Income (MAGI) can't exceed $144,000 if you file single or $214,000 if you file jointly.
Tax benefits: Contributions are made on an after-tax basis, your money grows tax free within a Roth IRA, and qualified withdrawals are tax-free.
Contribution limits: $6,000 ($7,000 if you're age 50 or older) for 2022.
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Solo 401(k)
A solo 401(k) may be best for small-business owners who don't have an employee other than a spouse. It offers many of the same perks as a traditional workplace 401(k), but its contribution limits are higher because you get to contribute as a business owner and as an employee to yourself.
Tax benefits: Contributions are tax deductible and investment earnings grow tax-deferred. Qualified withdrawals are taxed as ordinary income when you're at least 59.5 years old.
Contribution limits: Because you contribute to a solo 401(k) as both the employer and the employee, contribution limits are a bit complex. But here's a breakdown.
- As an employee, you can make contributions called "elective deferrals" in 2022 up to the lesser of $20,500 ($27,000 if you're at least 50) or 100% of your earned income.
- As an employer, you can make contributions or nonelective deferrals up to 25% of net compensation, which requires some complex calculations to determine.
- Total contributions to an account can't exceed $61,000 for 2022 for those under 50 or $67,500 for those 50 or over.
The solo 401(k) is officially called the one-participant 401(k) plan by the IRS. It also goes by the following.
- Solo-k
- Uni-k
- One-participant k
SEP IRA
A SEP IRA may be best for small-business owners with zero or few employees. This is because you're required to also contribute to any eligible employee's SEP IRA plan as well. And for each employee, you must contribute a percentage of compensation equal to your own. So if you contribute 10% of your compensation to your own SEP IRA each year, you must contribute 10% of each employee's compensation to his or her own account.
There is no Roth option of the SEP IRA that would allow for tax-free qualified withdrawals. Moreover, there's no "catch-up" contribution limit for people ages 50 or over. But the SEP IRA still has its perks.
Tax benefits: Contributions to a SEP IRA are tax deductible. Qualified withdrawals will be taxed as ordinary income.
Contribution limits: For 2022, SEP IRA contribution limits are the lesser of $61,000 or 25% of compensation.
SIMPLE IRA
The SIMPLE IRA was designed for business owners with 100 employees or less. Just as with the SEP IRA, you're required to contribute to your employees' SIMPLE IRA accounts. But you have two choices.
- Contribute at least 2% of each eligible employee's compensation into their account, regardless if the employee contributes to the account.
- Make a 100% matching contribution up to the first 3% of compensation.
Tax benefits: Contributions to SIMPLE IRAs are tax deductible. Qualified withdrawals would be taxed as ordinary income.
Contribution limits: For 2022, you can contribute up to $14,000 ($17,000 if you're 50 or older).
The bottom line
You don't need a 401(k) to start saving for retirement. As a freelancer or business owner, you have a handful of tax-advantaged accounts that you can open directly through a financial institution. But these aren't one-size-fits all solutions. For example, a small business owner with no employees may prefer a solo 401(k) over a SIMPLE IRA. And those who can't contribute much may be satisfied with a traditional IRA or Roth IRA. In any case, it's important to weigh your options and shop around for the best choice.
