Retirement Planning For The Self-Employed

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By Manas Das

The high of being self-employed never really wears off, does it? One year down the line or 10 years down the line, you wake up in ‘Freedom City’ every morning. It’s your call, your rules and your game! However, you owe it to yourself to keep that joy intact when retirement comes.

You take for granted certain benefits when you are employed full-time by someone else, including health insurance, disability, vacations, 401K match etc. But when you are on your own, you are literally on your own. So you should make self-employment retirement plans an integral part of your solo flight. You’re taking your ship home safe and steady.

Which Self Employment Retirement Plan Should You Choose When You Own Your Own Business?

Statistics say retirement could last for 30 years or more for an individual and a common rule of thumb is that a retired person would need up to 80 per cent of their current annual income to retire comfortably. Also, the average monthly amount paid by the Social Security Administration in the form of a benefit is only $1,153 a month. A self-employment retirement plan is therefore, an absolute must for solopreneurs.

Don’t worry, it’s not as troublesome as it sounds. A little research got me these basic facts and I think anyone could easily build their self-employment retirement account. There are three sections you need to consider:

  1. SEP plans: Under a SEP, you make the contributions to a traditional individual retirement arrangement called a SEP-IRA set up by or for each eligible employee, including yourself. A SEP-IRA is owned and controlled by the employee, and you make contributions to the financial institution where the SEP-IRA is maintained.
  2. SIMPLE plans: Generally, if you have 100 or fewer employees who received at least $5,000 in compensation last year, you can set up a SIMPLE plan. Under a SIMPLE plan, employees can choose to make salary reduction contributions rather than receiving these amounts as part of their regular pay. In addition, you will contribute matching or non-elective contributions. The two types of SIMPLE plans are the SIMPLE IRA plan and the SIMPLE 401(k) plan.
  3. Qualified plans. The qualified plan rules are more complex than the SEP plan and SIMPLE plan rules. However, there are advantages to qualified plans, such as increased flexibility in designing plans and increased contribution and deduction limits in some cases. There are two basic kinds of qualified plans: defined contribution plans and defined benefit plans. In a defined contribution plan, a certain amount is contributed to the employee’s retirement account and benefits are based on the amount contributed and accumulated in the employee’s retirement account. In a defined benefit plan, the benefits are pre-determined, and contributions are made based on what is needed to provide those benefits.

In these three types of plans, here are the most popular self-employment retirement plans with their basic advantages and limitations. To learn more about a plan, please click on the corresponding link or go to

Retirement Plan Key Features Pros Cons
Traditional IRA Can contribute an amount equal to your taxable compensation up to $5,000 if you’re under the age of 50, and $6,000 if you’re 50 or older. (for tax year 2012) Simple to set up, tax deferred growth You or your spouse should not have another retirement account, pay tax at withdrawal time
Roth IRA If you’re looking for tax-free growth and are within the income limits defined then you could try this plan. Basically, if you’re married and make more than $173,000, your ability to contribute to a Roth is reduced and then completely phased out once your income is above $183,000. If you’re single, the contribution phase out starts at $110,000 and your ability to contribute is completely phased out at $125,000. These numbers are for the tax-year 2012. Tax-free growth Income limits
SEP IRA You should be able to contribute about 25% of your net self employment income but your maximum contribution would be limited at $50,000 (for tax-year 2012). Easy to set up, standard forms Must contribute 20% of income. So it may not be a good idea if income is low.
SIMPLE IRA Requires dual contribution. One part from the employees and one from the employer. As a self-employed person you contribute a percentage of your net earnings plus either the matching contribution of up to 3% of your net earnings, or the non-elective contribution of 2% of your net earnings. Low or no cost plan, does not require an annual IRS filing, Matching or non-elective contributions you make as the employer are not subject to these taxes. Employers must make a contribution. For businesses with less than 100 employees only. Salary reduction contributions are subject to Social Security, Medicare and federal unemployment taxes.
SIMPLE 401K Requires a written plan which could be the prototype of an IRS or designed by yourself or your tax consultant. All financial institutions would help you set it up. You have to invest the assets of the plan in a custodial account or a trust with the help of a legal instrument. You would require legal help for this. You must issue a notification for your employees once the plan is established. Low-cost plan, Employer contributions might be vested over time according to plan terms, Unlike a Roth IRA, employees with relatively high incomes can still make contributions. Requires an annual IRS filing, Depending upon plan design might require employee discrimination testing.
Keogh This is a qualified retirement plan created by self-employed individuals but is a little complex and has certain costs associated with it. An individual with earnings from self-employment may create and fund a Keogh Plan, even if he is also an employee elsewhere covered by a workplace retirement plan. You can make very large contributions to the plan and still get a large tax deduction. Contributions get a tax deduction for the tax year to which the contributions are designated. The precise amount you can contribute to a defined benefit Keogh plan depends on sophisticated actuarial calculations.
Solo 401(K) Requires paperwork and is the newest self-employed retirement plan. The contribution limits are $17,000 if under age 50, and $22,500 if age 50 or older. You have to file informational returns once you have more than $250,000 in the plan. Many brokerage firms have low-cost solo 401(k) plan options and often allow you to invest in a broad array of investment options, similar to an IRA or SEP.


Manas Das is a management consultant, business coach and entrepreneur. In his over two decades of consulting experience, he has established himself as a trusted advisor in a wide range of industries – technology, utilities, financial services and non-profits – in the areas of strategic planning/execution and process improvement.

Manas received his MBA in Strategy, Finance and Entrepreneurship from the University of Chicago-Booth School of Business. He held senior-level management positions with PricewaterhouseCoopers, IBM and Freddie Mac leading cross-functional teams. After he got laid off from Freddie Mac a few years back, he decided to become self-employed. He has been a solo-preneur since then and genuinely loves it. He has also taken it up as his mission to help other aspirants become successful in their goals of self-employment.

Manas lives in Northern Virginia with his wife and two daughters. He spends most of his free time with his family, working out and on pro-bono consulting to small non-profits. He can be reached at manas at