Best Retirement Plans for Self-Employed People

by Neal Frankle, CFP ®

If you are self-employed you can open a variety of retirement plans. But which is best? I received an e-mail from Linda. She loves being self-employed, but she has a good question:

I’ve been wondering about restrictions on multiple retirement accounts. I’m young and I max out my Roth IRA every year. I’m self-employed and in a low tax bracket, but I may bump up next year because I’ve had more work.

I’ve saved more than half my income so far this year.

Would I be allowed to open a second retirement account? Which account would be best? Would this be a dumb idea since I wouldn’t be able to use that money (penalty-free) for 30 years?

Linda…let me tell you something. This is not dumb. This is brilliant for you to consider. And while I’m at it, kudos to you for saving half your income. That’s super impressive. Now…let’s get down to business and have a quick review of IRA restrictions and opportunities before I answer Linda’s question.

Linda’s Roth IRA provides tax-free growth and tax-free withdrawals. The trade-off is that these Roth retirement accounts don’t offer tax-deductible contributions. The traditional IRA (or other traditional retirement accounts) provides tax-deductible contributions and tax-deferred growth. Withdrawals, however, are fully taxed as regular income.

Neal’s Notes –  Most years, contribution limits change.  Here’s a link to the contribution limits for 2015.

Now, in most cases any money you contribute to a traditional IRA reduces the amount you can deposit to a Roth IRA. But there is one quirky Roth rule that Linda can take advantage of. Contributions to employer-sponsored plans don’t reduce Roth IRA contributions. That being the case, Linda should open an individual 401k, make contributions of up to 25% of her compensation (up to $16,500) and still contribute to her Roth.

Individual 401k plans are simple, straightforward and inexpensive. They also allow employers to make large contributions for their own retirement. Basically, this is a plan for self-employed individuals or small business owners who have no other full-time employees (an exception applies if your full-time employee is your spouse). The contributions are completely discretionary. You have the option of reducing plan contributions whenever you want to.

The only drawback is that the individual plans often have limited investment options.

Even though I normally encourage folks to go for the maximum tax deduction they can get now, Linda is in a different situation. She’s smart for focusing on the Roth now, but since she has other savings she should sock away some dough into the 401k.

True…she’s in a low bracket now so the write-off isn’t all that important to her. But as ambitious as she is, her income will go up faster than you can say “required minimum distribution.”

That means the tax deduction will be more important as the years pass. Bottom line, she should continue putting in as much as possible into her Roth and then start funding an individual 401k. This way, she gets the benefit of tax-free growth and retirement income. She also gets the benefit of a current tax deduction.




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{ 4 comments… read them below or add one }

Syed July 10, 2010 at 11:32 AM

I have two small business and both of them are incorporated in California and set up as S corp. One of the business I’m the only person and has no employee, but the other business has 5 employees which is operating at a loss. I want to set up a self employed retirement plan for myself for the first business only where I’m the only one involved. What are my choices for a self-employed retirement plan which offers me the maximum benefit and amount to be invested tax-deferred? Can I have such a plan for the business where I’m the only one without offering such plans to the other business with employees?


Khaleef @ KNS Financial June 3, 2010 at 9:48 AM

Good article. This provides a lot of helpful information and ideas for small business owners!


Neal June 2, 2010 at 6:05 AM

Thanks Nunzio….have you dealt w/many people in Linda’s situation?


Nunzio Bruno June 2, 2010 at 5:42 AM

Nice round up on the Individual 401k. Most folks don’t realize that it’s an actual option for their small business. You are spot on in planning for future income growth as well and it sounds like Linda will be in good hands.


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