Retirement Plans for Sole Proprietorships

by John Csiszar ; Updated July 27, 2017
Two small business owners.

Sole proprietors have a number of ways to sock away retirement money and can often make larger contributions than traditional employees. Plans available for sole proprietors are typically tax-deferred, meaning you can take a tax deduction in the year you make a contribution and won't face income taxes until you withdraw from your account. With multiple options available, it can take some analysis to determine what is the most appropriate plan for a particular sole proprietor.

General Benefits

As a sole proprietor, you can derive great benefits from using business retirement plans, particularly if you are the only employee of your firm. If you run a one-person sole proprietorship, you won't have to worry about making additional contributions for others to your plan. This can greatly enhance your own retirement savings. Sole proprietors are both employees and employers in the eyes of the law. With some retirement plans, this means you can make two contributions to your own plan -- one as an employee and one as an employer. Whether or not you can make both contributions, your allowable contribution limit is quite often much higher than it would be if you were the employee of another company.

SEP

A simplified employee pension allows you to put away 20 percent of your net business earnings after subtracting half of your Social Security and Medicare taxes. Since these are technically employer contributions rather than employee contributions, you'd have to contribute the same percentage for all of your covered employees that you make for yourself. At the time of publication, the maximum contribution you can make is $52,000, much more than the $17,500 limit that employees can contribute to 401(k) plans. Combined with the maximum 20 percent savings rate, this means that the maximum compensation that can be considered for a SEP plan is $260,000.

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Personal 401(k)

A personal 401(k) plan allows you to benefit from both employee and employer contributions. At the time of publication, the maximum employee contribution to a 401(k) plan is $17,500. However, an employer can kick in up to 25 percent of an employee's earned income. In the case of a sole proprietorship, that means you can put in both the $17,500 employee contribution and an additional 25 percent of your earned income, up to a maximum total contribution of $51,000. If you're over 50, you can contribute an additional $5,500. If you make an employer contribution to your own 401(k) plan, you'll also have to make contributions on behalf of your employees.

If you prefer to take your tax savings at the time of withdrawal rather than when you contribute, you can designate your employee 401(k) contributions as Roth contributions. You don't get a tax deduction right away, but when you withdraw from the account your money comes out tax-free.

SIMPLE IRA

A SIMPLE IRA is one of the easiest types of retirement accounts to establish for a sole proprietor. A SIMPLE IRA allows for both employee salary deferral contributions and employer contributions. As with some other types of retirement plans, a SIMPLE IRA requires you to contribute the same percentage for your employees that you contribute to your own plan. You can defer up to $12,000 per year into a SIMPLE IRA, but your contribution may not be greater than your net earnings from self-employment. Your employer contribution can be in the form of a 2 percent non-elective contribution or a match of your salary deferral contribution, up to 3 percent of your net earnings. At the time of publication, you can make a catch-up contribution of up to $2,500 if you are age 50 or older.

Custom Plans

If you're willing to put in the extra effort and expense, you may be able to create a custom retirement plan for your business. For example, an accountant or tax attorney can help you set up a defined benefit plan that could help you maximize your contributions. However, in addition to the extra cost required to establish and maintain such a plan, you'll be required to make annual contributions -- even in years when your business doesn't pull in a lot of money. These contributions will also be required for all your employees.

About the Author

After receiving a Bachelor of Arts in English from UCLA, John Csiszar earned a Certified Financial Planner designation and served 18 years as an investment adviser. Csiszar has served as a technical writer for various financial firms and has extensive experience writing for online publications.

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