How A Self-employed Person Can Choose The Best Retirement Plan In United States

Social security after retirement is a challenge that has been met largely with a very active involvement of the employer in United States. However, even for the self-employed, there are a number of options to choose from, which have tax benefits often comparable to those offered by the employer managed retirement benefit plans. As they offer different pros and cons, the plan that serves your purpose should be chosen with a lot of care.
How a Self-Employed Person can Choose the Best Retirement Plan in United States
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Planning for retirement is required for the self employed as much as it is a must for other categories of income earners. In fact, compared to those in employment, self-employed entrepreneurs may face a greater uncertainty in their career, and need to be prepared for the exigencies of older life in a more proactive manner.

Planning for Retirement: The Two Challenge for Self Employed

A self-employed person usually faces two simultaneous challenges, when it comes to retirement planning. The first is to plan retirement for her own self, while the second is to provide retirement planning options to her employees. If this

challenge does not immediately become apparent at first glance, it is because when a self-employed wishes to treat herself as an employee of the same business, she needs to extend the retirement option to all other employees in the same manner, thereby creating a somewhat complex interaction of choices, since similar obligations must then be undertaken for other employees.

Thus, the preferred choice of a retirement plan of a self-employed is likely to be governed by several factors. The first and the foremost of them is her ability to undertake obligations of regularly contributing for herself and the employees, keeping in view the available cash streams and number of employees. The second factor is the number of employees, and the level of their compensation. The third factor could be the age and desired level of retirement saving, since different options provide different levels of savings. The last factor would be the extent of preference for tax benefits, which constitute an important part of the retirement planning.

Keeping their needs in view, the Internal Revenue Code offers retirement plans that provide tax benefits to the self employed. The choice of the plan should take them into account.

Tax Benefits

Most of the plans, with the exception of Roth IRA, provide tax benefits on the contributions made to the plan up to the upper limit that has been prescribed on those plans. These tax benefits are available to the contributions made by the employee as well as the employer. So where the self-employed opt for a plan for employees and treat self as an employee, she gets the benefit of both contributions, but must extent the same benefit, without any discrimination, to other employees. Earning on the contributions made in the retirement plans are generally exempt from tax, and provide the biggest tax benefit.

In some cases, the trustee’s fees can also be deductible for tax purposes. Self-employed are also eligible to enjoy the tax credits for low to moderate income earners (Saver’s Credit) available on $2000 in a ratio to 10% to 50% depending upon gross income. Further, they are also eligible to get deduction of up to $500 per year for three years for setting up and administering retirement plans for employees. 

Best Retirement Plan Options

Solo 401(k) Plan: The Tax Effective Plan

The Solo 401(k) Plan, also known as the ‘One Participant 401(k) Plan’ has the advantage of offering significant tax benefits, but is applicable only for a self-employed person with no employees. Here the self-employed person can make contributions from the business profits up to the maximum limit permissible for total contributions to be made by the employee and the employer in a traditional 401(k) plan, and available tax deduction on it.

The upper limit for total contribution depends upon total business profits and age. The contribution is made up of two components. The employee contribution can be made up to the upper limit of $18,000 for the year 2017. For a person older than 50 years, an additional ‘catch-up’ contribution of $6000 is also permitted. The employer contribution can be made till the total contribution reaches up to $ 54,000 (excluding the catch-up of $6000 for over 50, which is permitted in addition), but the employer contribution must not exceed 25% of compensation. The maximum compensation that can be taken for this purpose is $270,000. It is important to note that for a self-employed the compensation cannot exceed the net self-employment income, so to contribute to the Solo 401(k) plan, you must have adequate earnings.

A very important facility in this plan, is the option of extending the same benefit to your spouse if he is employed by you. In that case, the same contribution can also be made for the spouse, which doubles the total contribution that can be made to the retirement planning by a married couple, and thereby enables them to get double tax benefit. Obviously, such an option requires adequate earnings, and is likely to be preferred by those in a position to save more. It could also be a preferred option for those who are somehow late in their retirement planning, but are making good earning now, and would like to catch-up quickly with their retirement planning goals.

Traditional IRA: The Simplest Option

The traditional IRA is one of the simplest solution available for self-employed persons, especially with employees, and where the objective is to provide a simple retirement planning option to the employees while also taking measures for your own retirement planning.

One of the disadvantages is the lower tax deduction limit for IRA contributions, which is only $5,500 for the year 2017, though an additional $1000 can be contributed by those over 50 years as ‘catch-up’ contribution. The biggest advantage is the ease with which IRAs can be opened with any online brokerages. IRAs provide certain flexibility since they can be combined with other

plans, in which case, the upper limit for tax deduction may change.

This plan is particularly preferable for self-employed in the early part of their careers, when retirement planning may not be at the top of their priority list. Since this plan can be opted for irrespective for whether you have employees or not, it is a good option, for those who are likely to employ more persons in near future, and would want to keep their obligations simple.

Roth IRA: An Additional Option without the Tax Benefit on contributions

Instead of the traditional IRA, one can also opt for Roth IRA, in which case, the contributions would not be eligible for tax deductions. It could be a preferable option for those earning low income, and falling into lower tax brackets. It could also be an additional option with other plans. The disadvantage could be locking up of precious resources, when you require them most, for a long period till you reach the age of 59 and a half years. It is an option that is more likely to be opted for due to special circumstances of a self employed person.

S E P Plan

A Simplified Employee Pension (SEP) Plan is an individual retirement account for a self employed person that can also be used for employees. All contributions are tax deductible as a business expense and can be integrated with Social Security contributions, and there is no minimum contribution requirement. The maximum contribution under this plan is $54,000 or 25% of participant's net earnings or compensation (maximum of $ 270,000), whichever is less.

The SEP plan usually requires a 'mandatory annual contribution' in which each year the same contribution will have to be made irrespective of the profit in that year, and the same will have to be extended to all employees who are 21 years or older and have worked for 1000 hours in a previous year. The SEP plan can also be managed as a 'Profit Sharing Plan' where contribution is linked with the annual profits.

The SEP plans owe their popularity to ease of setting up and administering, while providing tax deductible contributions that are much greater than traditional IRAs. In a way, they provide an option that can be compared with traditional IRAs in simplicity, and Solo 401(k) plans in upper limits of tax benefits. However, one must not forget that it requires non-discrimination between the self-employed person and her employees.


The 'Savings Incentive Match Plan' or 'SIMPLE' plan is a retirement plan that can be used by a self employed and also applied to employees. These programs are attractive because they don't incur many of the administrative fees and paperwork of plans such as the 401(k). In this plan, the contributions are made in two forms, the ‘elective salary reduction contribution’, and the ‘matching or fixed non-elective contribution’. The contributions are tax deductible and free from tax up to $ 12,500 for salary reduction contribution for the year 2017, with additional ‘catch-up’ contribution of $3000 permitted for those over 50 years. The upper limit for employer contribution is 3% of compensation in case of matching, and 2% of compensation in case of fixed non-elective contribution.

The SIMPLE plans are generally popular with more employees, as they provide an option, whereby the employees determine their own contribution by tax deferral from their contribution.

Defined Benefit Plan

A defined benefit plan provides fixed returns after retirement. Its advantage generally lies in providing an opportunity to a self-employed person who wishes to make relatively larger contributions for a higher retirement income. The contributions are generally tax deductible. The plan could also be useful, if you have a few highly compensated employees, with similar preferences. It could also be an option worth considering for those nearing the age of retirement.

The disadvantages lie in the complexity of the plan, and the higher administrative costs. With a large number of lowly compensated employees, it can be somewhat costly to administer.

How to Choose the Best Plan

Since different plans provide different advantages and disadvantages, the choice of the plan is likely to differ with different plans. It is for the person to understand her priorities and take a call on what she considers more important. For a self-employed person without employees, looking to maximize the tax deductions, the solo 40(k) plan offers a good option. For someone looking for the simplest of options, a traditional IRA is likely to be preferable. For someone in the lower tax bracket, a Roth IRA may be a good option. For someone willing to get into the complexities of defined benefit plan, it can also be an option worth considering.

What is important while making a choice, is to be aware, and take an informed decision!

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