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Best Retirement Plans for Solopreneurs

Posted December 23, 2021

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As a business owner, and that’s what you are as a solopreneur or 1099 contractor, the world is your oyster when selecting the best retirement plan for yourself. It is essential to understand that you are not limited to the $6k IRA contribution. You can defer up to $58k per year into a qualified retirement plan (think 401k) and, depending on your age, potentially hundreds of thousands per year (if not millions) into a defined benefit plan (think pension).

One of the biggest rules around qualified retirement plans is that you cannot discriminate against rank and file employees. ERISA law put this provision into place to keep business owners from taking advantage of the tax benefits of these programs without also contributing to their employee’s financial well-being, which makes a ton of sense. The nice little loophole is that if your business is just you (your spouse is included), you don’t have any employees. You can max out these programs, and you won’t run into ERISA nondiscrimination testing violations.

So what does this mean for you precisely, and which retirement plan will best serve your purposes?

There are a couple of essential things to consider when selecting a retirement plan for your business. First, do you plan to add full-time employees in the future? Second, are you willing to contribute to your employee’s retirement account? Third, do you have consistent or growing profits every year?

These are essential factors in determining which retirement plan will be best for you and your business initially. I have broken down each of the retirement plan options available (all numbers will be based for 2022):

Retirement Plans

Solo 401k

The first retirement plan that you will want to consider is the Solo 401k. This Solo 401k is limited to businesses with no employees. The Solo 401k allows you, the business owner, and your spouse to defer $20,500 (plus an additional $6,500 if you are over 50) of your compensation into the plan. You can also make an extra profit-sharing contribution to the plan (up to 25% of your income). As of 2021, the maximum amount of money you’ll be able to defer into this solo-401k each year is $61,000. Being able to defer this much money can result in a sizeable tax deduction for you and your spouse. The beauty of this type of plan is that it is also completely flexible and discretionary because you can decide how much and when you will contribute to the plan.

If you ever hire an employee, you will need to upgrade to a full 401k plan to include the employee (this comes with additional costs and complexity), or you can terminate the solo-401k.

SEP IRA

Another typical retirement plan for solopreneurs is the SEP-IRA. The SEP-IRA is a straightforward plan to implement, but it can be costly if you start hiring employees. A SEP IRA allows you to defer up to 20% of your net adjusted annual self-employment income with a maximum of $61,000. SEP IRAs are straightforward to maintain, but they do have their limitations. The most significant restriction that a SEP IRA has, and it can be a show stopper, is that if you add an employee, the employee will be required to receive the same percentage contribution into the SEP-IRA. For instance, if you want to contribute 15% of your income to your SEP IRA, you must make a 15% contribution to each employee’s SEP IRAs. This can get costly for employers who want to contribute money into their accounts.

SIMPLE IRA

A SIMPLE IRA is like a small 401k plan without all the red tape. However, for a solopreneur, there is no reason to do a SIMPLE IRA when the Solo-401k is available for them. The SIMPLE IRA limits deferrals to $14,0000 (and an additional $3k after age 50) instead of the solo-401k’s $61k maximum. The SIMPLE IRA could potentially be a better fit for your business once you add employees. This would depend on your tax bracket, the number of employees, and their salaries.

Defined Benefit Plan

One of the most interesting retirement plans available to an individual business worker is the defined benefit plan. When people think of pensions, they typically think of major corporations or government workers, but you can establish one for yourself. It takes lots of stable cash flow and a high income for a defined benefit plan to make sense, but if it does, you would have the ability to defer 100k’s, if not millions of dollars per year, into this kind of plan.

How is this possible? When you set up the defined benefit plan, you can create the benefits for your plan. If you design your plan to provide the maximum benefit of $245,000 per year, you have to fund your plan with enough money to meet this benefit requirement. For instance, if you are 60 years old and the retirement age for your plan is 65, then you would need ~$5.75M in this defined benefit plan by age 65 to achieve this goal. That would mean that you would have to put over $1M annually into this plan to fund the income benefit provided by the plan adequately

If you are younger, you will not put as much money into the plan because you have more time (and market growth) to fund this account adequately.

Stable and consistent income is imperative for this type of account. Unlike all the other retirement plans mentioned that are flexible and don’t require contributions, once you establish a defined benefit plan, you will be required to fund the plan each year.

Many costs and complexities are associated with implementing and maintaining a defined benefit plan, but the tax benefits can usually far exceed these costs.

Conclusion

I hope this has helped break down the pros and cons of each retirement plan available to you as a solo business owner. Before implementing any of these options, it’s always important to speak with a financial professional about what is right for your particular situation and ask questions when you are unsure about something.

Thayer Financial is ready to advise you on your retirement options and help you create a financial plan from the perspective of comprehensive financial planning to enjoy every moment of your retirement. Thayer Financial is your dedicated resource for fee-only, fiduciary advice as financial advisors in Hickory, North Carolina. Schedule an appointment or call us today.


Thayer Financial, L.L.C. (“Thayer Financial”) is a registered investment adviser offering advisory services in the State of North Carolina and in other jurisdictions where exempted. Registration does not imply a certain level of skill or training. This website’s presence on the Internet shall not be directly or indirectly interpreted as a solicitation of investment advisory services to persons of another jurisdiction unless otherwise permitted by statute. Follow-up or individualized responses to consumers in a particular state by Thayer Financial in the rendering of personalized investment advice for compensation shall not be made without our first complying with jurisdiction requirements or according to an applicable state exemption.

All written content on this site is for information purposes only. Opinions expressed herein are solely those of Thayer Financial, L.L.C., unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to other parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.


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