WBS: Episode 14 – Retirement Savings for Self-Employed Individuals

More than 30 percent of the US workforce is either self-employed or working for someone who is self-employed.  This number is expected to rise rapidly in the coming years.  Without the benefit of a comprehensive workplace retirement plan, self-employed individuals need to look at their income, cash flow needs and savings opportunities in order to determine the best vehicle for setting up their own retirement savings.  Technology has made it very easy for individuals to set up a savings and investing strategy and self-employed workers need to be aware of the important opportunities to set aside money and save taxes in the process. 



The Whiteboard Series is a continuous exploration and discussion across a wide range of personal finance topics. Through a series of drawings, interviews and explanations, we hope to educate and simplify important financial planning principles. 

Video Transcript

On today’s Whiteboard Series I want to talk about Retirement Savings for the Self Employed.  According to the Bureau of Labor and Statistics, self-employed individuals in the US now make up more than 30 percent of the workforce – a number that’s projected to increase rapidly as more Americans – particularly millennials – choose independence and flexibility over the more structured corporate world.  But what about retirement savings for these individuals? 

Most companies or organizations offer some type of retirement savings plan – such as a 401(k) – that workers can save into.  In these plans, companies set up a plan, set some rules and choose a custodian that will hold all of the accounts.  Most plans also include some type of matching provision or profit-sharing aspect to it, and employees divert money from their paychecks to fund their retirement accounts.  

But for people working for themselves, they obviously don’t have the benefit of that same structure or opportunity.  So, what can they do?  First of all, anyone can always set up and save into an IRA – whether it’s a traditional or Roth IRA, depending on their income.  But IRAs have contribution limits – currently $6,000/year, plus an additional $1,000/year if you’re over the age of 50.  These contribution limits are much lower than what are allowed by other retirement plans, so for higher earning self-employed individuals looking to set aside more significant amounts of money, they need to look to something else. 

The 2 primary options at this point are the SEP IRA and the Individual 401(k). 

The SEP IRA, which stands for Simplified Employee Pension, is a little more of an old-school plan for the self-employed that’s probably not as ideal today given the existence of the individual 401(k). 

SEP IRAs let an individual contribute 25% of their self-employment income, up to $56,000 in 2019.  So let’s say this individual has $100k of self-employment income.  The actual calculation, once you take into account some adjustments and self-employment taxes is actually like 18.5 percent of net income, so in 2019, this individual could put away 18,500 into a SEP IRA.  Not bad, more than $6,000 into an IRA, so moving in the right direction, but what about other options?

The Individual 401(k) is a relatively newer option, they’ve been around since the Bush tax cuts in 2001.  As its name implies, it functions like a 401k plan, meaning there can be both employee and employer contributions, even though in in case, the employee and employer are the same person.  So let’s take the same example of the individual with $100k of net income.  Because this is a 401k plan, the individual can defer $19,000 of their income into the plan, just like an employee working for a large organization.  In addition to that employee contribution, the employer can make a profit-sharing contribution, of 25% of the net income of the business.  Same calculation as the SEP IRA, the actual contribution is closer to 18.5%, but you can make the $18,500 contribution in addition.  For total contribution of 37,500.