Retirement Planning for Solo Business Owners

Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®
In our last paper, we went over the best retirement plans for your small to medium-sized business. However, those retirement plans may not be helpful for you if you are the sole employee of your business or are a freelancer, such as a 1099 worker. In this paper, we’ll go into the top retirement plans available as the sole earner in your business, side gig, consulting practice, or freelancing job.

Defined Contribution Plans

The Solo 401(K)

We’ve all heard of the 401(K), which is, by this time, the backbone of Americans’ retirements. However, you may not be aware that you can open a 401(K) if you are the sole owner of your company and don’t have any employees. It’s also available to freelancers and side gig workers, even if you have another job and contribute to your workplace 401(K). However, the benefits of a Solo 401(K) are even more advantageous than a standard 401(K).

Solo 401(K) Contribution Limits

First, the Solo 401(K) is unique in how it is funded. As the owner of a Solo 401(K), you can fund it as BOTH the owner and the employee, allowing for significantly higher contribution limits. You can also contribute traditional pre-tax or post-tax Roth dollars, giving you greater tax bracket management flexibility, and if your spouse works for the business, they can contribute as well without breaking the ‘solo’ stipulation. 

In 2024, you can contribute: 

As the employee: $23,000  

As the employer: $46,000

Total: $69,000

Catch Up Contribution (50+): $7,500

Age 50+ Total: $76,500

Keep in mind that these are only maximum limits. If you’d like to contribute less or even none, it’s entirely within your rights as a self-employed individual to do so.

Solo 401(K) Eligibility & Spousal Limits

You can establish your own Solo 401(K) as long as you generate income as a self-employed individual through freelance work or a small business and you don’t have any employees other than yourself and your spouse. 

Combined Couple Limit: $138,000

Combined Couple Limit (50+): $153,000

It’s difficult to overstate the significance of being able to contribute such an amount to a tax-advantaged retirement account. If you and your spouse begin contributing the maximum amount for couples, you will have already saved over $2,000,000 at age 65, not including any contribution limit increases and potential growth. Your spouse must be an active member of the business, however.

Self-Directed Investment Options

When you contribute to a Solo 401(K) plan, you have a whole world of investment opportunities available to you. If you’ve ever looked into a workplace 401(K) plan, you probably noticed the limited investments available. That’s not the case with a Solo 401(K). As the plan’s trustee, you can purchase any combination of investments, such as stocks, bonds, ETFs, mutual funds, REITs, and alternative investments. 

However, with this opportunity comes greater responsibility. Financial professionals choose the funds available in a traditional workplace 401(K). You essentially have two options for your Solo 401(K) investments – do your due diligence and select the assets you feel would best get you to retirement, or reach out to a fiduciary financial advisor for advice. 

Penalty-Free Loans

If you ever need early access to your retirement funds in an emergency, it is possible to borrow from your Solo 401(K). Besides owing interest on it, you have to pay the loan back within five years to avoid a penalty. However, the interest will be paid into your retirement account, not a bank. 

Simplified Employee Pension (SEP) IRA

Our previous paper on retirement plans for small businesses discussed the SEP IRA, so we won’t go into too much detail here. For the record, though, a SEP IRA is an attractive option for solo business owners, including freelancers and 1099 workers, as it presents a straightforward, flexible, and beneficial route to retirement savings.

High Contribution Limits: In 2024, you can contribute up to 25% of your net earnings, with a maximum of $69,000, significantly higher than a non-workplace, traditional IRA. 

Simplicity & Flexibility: A SEP IRA has minimal paperwork, no complex administrative requirements, and low fees. Setting one up is straightforward and can often be done with an online application. The ongoing maintenance is equally hassle-free, with no annual filing requirements for business owners with no employees. 

Tax Advantages: Contributions to a SEP IRA are tax-deductible, reducing your taxable income in the contribution year; additionally, your earnings grow tax-free until you begin making withdrawals in retirement. With the passage of Secure 2.0, Roth contributions are also permissible. 

Investment Choices: As with a regular IRA, a SEP IRA offers a wide range of investment options. You can choose from stocks, bonds, mutual funds, ETFs, and more, tailoring your investment strategy to match your risk tolerance and retirement timeline. 

Early Access and Loans: Like other IRAs, early withdrawals from a SEP IRA are subject to taxes and penalties, emphasizing the plan’s focus on long-term retirement savings. While loans are not permitted, the plan’s contribution flexibility provides some financial leeway in managing cash flow.

SIMPLE IRA

A SIMPLE IRA also provides a straightforward and manageable approach to saving for retirement as a Solo Business Owner.

Ease of Establishment and Maintenance: Setting up and maintaining a SIMPLE IRA is particularly straightforward, with minimal paperwork and a low administrative burden.

Contribution Flexibility: As both the employer and the employee in your business, you have the flexibility to contribute up to $16,000 (for 2024) to your SIMPLE IRA. If you’re over 50, you can also make catch-up contributions of an additional $3,500.

Tax Benefits: Contributions to your SIMPLE IRA are tax-deductible, which can provide immediate tax advantages. The earnings in the account also grow tax-deferred until withdrawal.

Simplified Funding: Without employees, you avoid the complexities of matching contributions, making it easier to manage your retirement savings.

Investment Choices: Like a Solo 401(K) or SEP IRA, a SIMPLE IRA is self-directed, meaning you have a wide range of investment options.

Early Access & Loans: In case of a qualifying financial need, you have the potential to withdraw funds from your simple IRA without penalty. However, federal and local taxes are likely to apply. Unlike other retirement plans, a higher 25% penalty may be imposed for non-qualifying early withdrawals within two years of your first contribution. Like a SEP IRA, loans are not allowed.

Defined Benefit Plans

Many view pensions as relics of the past, now largely replaced by Defined Contribution Plans like the 401(K). However, there may still be a place in your retirement portfolio for a pension plan. Here are the two major types:

Personal Defined Benefit Plan

A Personal Defined Benefit Plan can be particularly suitable for high-income earners, such as freelancers, consultants, and small business owners, who want to aggressively save for retirement without the risk associated with more modern retirement plans.

Defined Benefit Plan Contribution Limits

A defined benefit plan allows for much higher contribution limits than an IRA or 401(K). While the exact contribution amount is determined based on several factors, such as your age, income, and the intended retirement benefit, you can expect to be able to contribute well over $100,000 for a year, possibly even over $200,000 if you earn enough, outshining even the Solo 401(K).

High contribution limits not only accelerate retirement savings but also offer substantial tax benefits, as these contributions are generally tax-deductible and grow tax-free until withdrawal, allowing you to keep taxes low in those peak income-earning years of your 50s.

However, there is a substantial commitment; once established, annual contributions are generally mandatory to maintain the plan’s funding status.

Predictable Retirement Income

As hinted at above, one of the main advantages of a Defined Benefit Plan is the predictable benefit monthly retirement payment, diametrically opposed to the guessing game of a defined contribution plan. Your monthly payment is based on your salary history and years of service rather than investment performance. However, that doesn’t mean investment performance doesn’t play a significant role. 

Investment Options

The investment management in a Personal Defined Benefit Plan is typically handled by you or a professional financial advisor, and a wide variety of assets are available to you, such as ETFs, mutual funds, stocks, bonds, and Certificates of Deposit. As mentioned above, your benefit amount doesn’t depend on investment performance; however, investment performance directly affects your contribution requirements. 

If your assets perform poorly, your plan may become ‘underfunded,’ meaning you’ll have to contribute more funds from your salary. Conversely, if your assets perform exceptionally well, your plan may become ‘overfunded,’ and your contribution requirements may be temporarily reduced.

Early Access and Loans

Unlike 401(K)s, Defined Benefit Plans generally do not allow for penalty-free loans or early withdrawals. The focus is on long-term, steady growth to ensure the promised benefit at retirement.

Cash-Balance Plans

Cash-balance plans may appeal to small business owners and professionals seeking a blend of high contribution limits, tax benefits, and stability. It shares similarities to both defined contribution plans and defined benefit plans; rather than a guaranteed monthly income stream that a traditional pension provides, it instead provides a guaranteed end balance.

Contribution Limits in Cash-Balance Plans

Cash-Balance Plans also allow for higher contributions than IRAs or 401(k)s. Actual contributions are placed in a plan trust, and you will have a separate ‘hypothetical’ account that shows your balance. The amount grows annually through contributions and a predetermined interest rate. 

There isn’t a uniform contribution limit; instead, contribution limits depend on the owner’s age, income, and the existence of other retirement plans. Since the plan specifies the annual contribution and the interest credit, you can forecast the account balance at retirement more accurately than with a 401(k) plan. Like Personal Defined Benefit Plans, Cash-Balance Plans require a commitment to annual funding.

Upon retirement, you have the option of receiving a lump sum or rolling your savings into an annuity.

Contribution Limits in Cash-Balance Plans

The difference between your investment options between a Cash-Balance Plan and a Personal Defined Benefit Plan is subtle. In a Cash-Balance Plan, you are expected to choose conservative investments that align with the plan’s interest credit rate. It’s highly advisable to utilize the services of a financial professional to determine the optimal assets to ensure compliance. 

Making the Choice

When deciding between these plans, consider the following:

  • Contribution Room: If you can save a significant portion of your income, the Solo 401(k) with a combined  spouse limit and Personal Defined Benefit Plan offer higher limits than the SEP IRA.
  • Income Stability: Do you have a stable, high income? If so, the Personal Defined Benefit Plan’s required consistent contributions shouldn’t be a concern.
  • Financial Flexibility: Need the option to borrow from your plan? The Solo 401(k) provides flexibility, whereas the other two do not.
  • Growth Potential: Are you interested in actively pursuing potential market gains? Investment performance plays a greater role in a Solo 401(K) and IRA compared to the Defined Benefit Plan. 
  • Administrative Simplicity: If minimal paperwork and ease of management are important to you, the SEP IRA is likely appealing.
  • Retirement Income Certainty: If a guaranteed income in retirement is a priority, the Defined Benefit Plan is perhaps a good fit.

Ultimately, the right plan for you depends on your income level, your desire for savings predictability or growth, and the importance of flexibility in contributions and access to funds. Each plan has its merits and may be the best fit for different types of business owners. Consider your current financial situation, future income projections, and retirement goals, and consult with a financial advisor to help guide your decision.

In Conclusion

As a small business owner, freelancer, or 1099 worker, the responsibility for retirement planning lies squarely on your shoulders, and you have many factors to consider: contribution limits, income stability, financial flexibility, investment control, administrative ease, and retirement income certainty – to name a few.

Whether you opt for the flexible Solo 401(k), the dependable pension plan, or the straightforward IRA, the key is to choose a plan that aligns with your individual financial goals and business trajectory. 

We encourage you to continue the conversation with a trusted financial advisor who can help tailor a retirement strategy to your specific needs. With thoughtful planning and the right retirement vehicle, you can navigate toward a future where your golden years are as rewarding as the solo business journey that led you there.

Disclosures

Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment or strategy will be suitable or profitable for a client’s portfolio. All investment strategies have the potential for profit or loss. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author/presenter as of the date of publication and are subject to change and do not constitute personalized investment advice.

A professional advisor should be consulted before implementing any investment strategy. WealthGen Advisors does not represent, warranty, or imply that the services or methods of analysis employed by the Firm can or will predict future results, successfully identify market tops or bottoms, or insulate clients from losses due to market corrections or declines. Investments are subject to market risks and potential loss of principal invested, and all investment strategies likewise have the potential for profit or loss. Past performance is no guarantee of future results.

Please note: While we strive to provide accurate and helpful information, we are not Certified Public Accountants (CPAs). The information in this article is intended for informational and educational purposes only and should not be interpreted as tax advice. It is crucial to consult with a CPA or tax professional to discuss you

Author

  • Ken Hargreaves, CFP®, AIF®, AWMA®, CRPC®

    A Florida native, and full-time Sarasota resident, Ken founded WealthGen Advisors, LLC after spending more than fourteen years in the financial advisory industry. Ken holds multiple industry designations, as well as a master's degree in Financial Planning. Prior to founding WealthGen Advisors, Ken spent almost a decade in New York and then Texas as Vice President at The Capital Group, a $2T global investment manager serving institutional clients and pension funds.

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