Several types of tax-deferred investment plans are available for the self-employed. Here are some fast facts about the following deferred investment plans: Simple IRA, Solo 401(K), Defined Benefit Plan, Keogh and SEP IRA.
- SIMPLE IRA plan - designed for small businesses with less than 100 employees and the self-employed, and requires an employer contribution. A percentage of pay is put aside (up to 25%, and this amount can be adjusted each year) and is able to grow tax-deferred. Taxes are paid at the time of withdrawal. You must start taking Required Minimum Distributions the year you turn 72. If you take a distribution before age 59.5 you will pay income taxes and a 10% early distribution penalty unless certain criteria are met acting as exceptions to this.
- Solo 401(k) - designed for self-employed (and their spouse if they are employed by the business). No age or income restrictions. Contribution limit of $58K in 2021 and $61K in 2022 (with additional $6500 catch up contribution for those age 50 or older). With Solo 401(k) you can opt for traditional 401(k) --contributions reduce income in the year they are made and distributions in retirement are taxed as ordinary income, or the Roth solo 401(k)--no upfront tax break but distributions at retirement are tax-free. Both plans face penalties and taxes if you withdraw before age 59.5.
- Defined Benefit Plan - This is a pension plan where guaranteed benefits are calculated. Defined benefit plans allow you to reduce your taxes while funding your retirement. This tax-deferred plan allows for very high deductible contributions of $100-$250K, which could potentially be doubled if your spouse is an employee added to the plan. After retirement this plan can be rolled over to an IRA for continued tax-deferral and can be combined with 401(k) plans for additional deductions.
- Keogh Plan - a tax-deferred retirement plan that can be set up as a defined benefit or defined contribution plan. Can begin withdrawing at 59.5 but don't have to start to withdraw until 70.5. Can only be used by individuals who own an unincorporated business (and their employees). All contributions to this plan must be done pre-tax, and all taxes on this plan must be paid in full at retirement.
- SEP IRA (Simplified Employee Pension) - a type of traditional IRA set up for self-employed individuals, employers with one or more employees, or freelancers. It has contribution limits of 25% of earnings. The contributions to a SEP IRA are not taxable until withdrawal.
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