4 Ways For The Self-Employed To Save For Retirement And Minimize Taxes

Running your own business, being self-employed or even having a side hustle is a great way to move towards financial freedom. There are multiple options available when it comes to choosing a retirement plan. Which plan is the best will depend on your business, how much you need to be saving for retirement, and your overall household income. Current tax rates and policy also play a role in which retirement plan you utilize from year to year.

Keep reading as we outline the four most common retirement plans for self-employed individuals. These retirement plans permit contributions ranging from $6,000 to nearly $300,000, per year!


Traditional and Roth IRA Rules

The Roth IRA and traditional IRA are best for those looking to save a modest amount of money each year. These accounts can also be funded in addition to one of the other retirement plans listed below. 


For 2021, the maximum contribution to a Roth IRA or traditional IRA is $6,000 or $7,000 for those who are 50 years or older. There are income limitations when contributing to a Roth IRA, so those with higher incomes may be ineligible. Income limits apply to traditional IRAs only if someone in the household has access to a retirement plan at work. For example, if your spouse has a 401(k) at his or her job.


You can contribute to an IRA (traditional or Roth) up to the tax-filing deadline for the prior year. 



The SEP-IRA is one of the most popular retirement plans for small business owners. Your maximum contribution in 2021 is $58,000, and your actual contribution is based on 25% of employee pay or 25% of your net earnings from self-employment income. The SEP-IRA works best when you have few to no employees.  


Setting up a SEP-IRA is easy and with minimal paperwork. Contributions can be made by October 15th of the following year. So, I’ve seen many small business owners set up SEP-IRAs when they received surprisingly large tax estimates for the prior year.


Individual or Solo 401(k)

The Solo 401(k) (or Individual 401(k) plan) is quickly becoming the best option for many business owners. The cost complexity of implementing a Solo 401(k) has come down dramatically over the past few years. The Solo 401(k) offers the opportunity to make the largest contributions, as well as the widest array of tax-planning opportunities for high-earning couples.


On paper, the maximum contribution limit to the Solo 401(k) is similar to a SEP-IRA, but it is easier to be allowed to make the max contribution. As a business employee, you can contribute $19,500 in 2021, plus an additional $6,500 catch-up contribution for those 50 and older. The employee contribution can be 100% of your salary compared to the 25% contribution limit on the SEP-IRA. From there, the business can make a profit-sharing contribution equal to 25% of your salary, for a grand total of $58,000 in 2021 ($64,500 if you are at least 50 years old.


The Solo 401(k) can also be set up as a Roth 401(k). However, only the employee contribution will go into the Roth bucket; the employer contribution will still be made pre-tax.


Defined-Benefit Plan

The Defined Benefit Plan is essentially a way to both lower your current taxes and create your own personal pension. 


The Defined Benefit Plan is typically combined with a 401(k) plan, allowing for a maximum contribution of $294,500 between the two plans. You are able to get more benefit from a combined 401k and defined benefit plan the more income you have and the higher your tax brackets are.


These plans work the best for firms when the income is skewed toward the business owners (and their families). Solid cash flow, and the ability to save more than $100,000 towards retirement accounts, are essential to starting this personal pension plan. Below this amount, one could get similar benefits with the Solo 401(k) and other tax-efficient investment strategies). While this may seem like a huge number, keep in mind it is a pre-tax number. In a high tax state, this might only cost $50,000 to put $100,000 into your retirement accounts.


Setting up a defined benefit plan is more costly and complex than the other retirement accounts mentioned in this post and should be set up with a financial planner, actuary, and guidance from your accountant. The plan can be designed to maximize contributions and benefits to you and your most valued employees. The ongoing contributions will need to be made to the plan but can be frozen if the business hits an iceberg, as many did during the COVID recession.


Hopefully, you are already contributing to some type of retirement account. First do what you can do to increase contributions or max out those accounts. Once you reach that level, work with your accountant to see what is next on your tax-minimizing strategy to help you keep more of your hard-earned money. The consensus is that tax will be going up in the future, and part of my job is to help my clients pay the least amount of taxes legally possible.

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