How to Save for Retirement When You're Self-Employed

Posted by Nailah Herbert in CareerOctober 3, 2022(Last Updated October 3, 2022)4 min read
Key Takeaways
  • When working for a company, an established system is in place to help employees save for retirement.
  • However, there is no pre-existing plan for self-employed individuals, making it difficult to determine which retirement plan is most suitable.
  • If you are self-employed, there are many types of retirement accounts that you can benefit from.
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No one plans to work forever; typically, most people wish to spend the latter years of their lives doing things they enjoy. A retirement plan should be set up as soon as you can contribute to it in order to retire comfortably. However, saving for retirement becomes a little more difficult. Below are some of the different types of retirement accounts a self-employed individual can set up. Below is an outline of five different types of retirement accounts for a self-employed individual.  

 

How Saving for Retirement Works When You're Employed

 

Some jobs have a pre-existing retirement system in place for their employees. If you choose to opt into the preferred retirement account with your job, then you can contribute every time you receive a paycheck. 

 

Also, every time you get paid, a portion of your income will be set aside for mandatory deductions, such as the Social Security and Medicare tax. This tax totals 12.4%, with 6.2% coming out of the employee’s income, and these contributions are tax-deductible, meaning your employment taxable income will be lowered.

 

Recommended Read: Seven Options to Save You Money on Taxes in 2022


Typically companies offer a couple of retirement accounts that employees can choose from, and after the mandatory deductions are taken from your gross pay, that is when you can begin putting money aside. Unfortunately, the process is not the same when you are self-employed. There is no one to create your retirement account, and it is up to you to determine which one best suits your needs. 

 

Below is a list of different retirement accounts a self-employed person can choose from to save for retirement so they can enjoy the final 20 years or so of their lives how they please. 


Different Types of Retirement Accounts

 

One Participant 401(k)

 

The one participant 401(k) is a retirement account that can be used only when you are a sole proprietor. A sole proprietorship is when you have no employees and are the only worker in the business. As mentioned above, the Social Security and Medicare tax is 12.4%, or 6.2%, for both the employee and employer. 

 

retirement plan

Image Credit: Casper1774 Studio / Shutterstock.com

 

In this situation, since the owner of the sole proprietorship is both the employee and employer, it means they are responsible for the total 12.4% that is allocated to the Social Security and Medicare Tax. But, being a sole proprietor also means that the contributions made to the retirement account will be tax deductible from the employee (personal income) and employer (business income) perspective. 

 

Recommended Read: 401(k) vs. IRA | Which One Should I Choose?

 

Traditional IRA


With this account, you will make tax-deferred contributions until you withdraw them at retirement. You may even have the opportunity to deduct these contributions from your tax return. This particular IRA account has a contribution limit of $6,000 for those under 50 and $7,000 for those exceeding the age threshold.

 

The Traditional IRA is the most convenient and easiest way to set up a retirement account. Due to its simplicity, opening an account does not take long, nor will it require excessive paperwork. 

 

Roth IRA

 

With the Roth IRA, you can contribute to it similarly to a Traditional one, with one major difference. The contributions made to the account will be after-tax, meaning any gains made on investments through this account cannot be taxed later. Also another retirement benefit this account gives is that withdrawals made during your retirement days cannot be taxed either. 

 

roth ira

Image Credit: Yuriy K / Shutterstock.com

 

SEP-IRA


A Simplified Employee Pension Plan (SEP-IRA) is also an option that you can explore for retirement if you are self-employed or an independent contractor. This plan provides access to tax-deferred savings for retirement.

 

The main benefit of this retirement plan is the contributions will be tax deductible, meaning there will be less income tax to be paid. 

 

Recommended Read: Tax Professionals Can Save You Time and Money on Your Taxes


SIMPLE IRA

 

Savings Incentive Match Plan for Employees (SIMPLE) is an IRA account with identical withdrawal rules to a Traditional IRA account. The major difference between the SIMPLE and Traditional IRA is the employer must match all contributions made by an employee to the account. Furthermore, another benefit of this account is the contribution limits.

 

The SIMPLE IRA allows account holders to contribute up to $14,000 annually. Since the employer must match the contributions made by the employee, this particular retirement account is fairly popular amongst self-employed individuals since they can contribute double the amount to their retirement account. 

 

Why Retirement Accounts Matters

 

A retirement account is crucial since it typically contains the majority of your income after you stop working. When you are not working, there is no steady income, meaning the only money you will have access to will be the amount put aside in your investment and retirement accounts. 

 

old couple looking at computer

Image Credit: Proxima Studio / Shutterstock.com

 

As a result, one main influencing factor of how well you will be financially is the sum of money set aside. During retirement, your expenses will not stop, and your income will reduce significantly, so ensuring that you have sufficient retirement income is key. 


The Money Wrap-Up


Deciding to start your own business is a tough decision to make. It is important to ensure that you have a savings plan in place, so your income is spent wisely. Determining the ideal retirement account can be difficult, which makes due diligence a crucial factor in the process. Therefore, to have the best chance of finding a retirement plan that works for you, consider your financial goals. 

 

Disclaimer: The information in this article regarding retirement planning and accounts should not be considered financial advice. Always consult a financial advisor and research federal government websites to attain the most accurate information. 


Main Image Credit: Chaay_Tee / Shutterstock.com

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