By Dr. James M. Dahle, WCI Founder
Just because you are self-employed doesn't mean you don't have options to save for retirement. Here's a rundown of the best retirement options for self-employed workers.
Retirement Accounts for the Self-Employed
There are many advantages to being self-employed when it comes to saving for retirement. As an independent contractor (i.e., paid on a 1099 instead of a W-2), you are considered to be running your own business. Just like your employer gets to pick the benefits it offers, you now get to choose (and pay for) your own benefits. While the self-employed miss out on a 401(k) match from an employer, you are also no longer limited by the employer’s contribution limits, plan fees, or often poor investment options.
Retirement Options for Self-Employed
- Individual 401(k)
- SEP-IRA
- Backdoor Roth IRA
- HSA
- Defined Benefit/Cash Balance Plan
- Taxable Brokerage Account
Independent Contractor 401(k)
The mainstay of retirement saving for the self-employed should be an individual 401(k), sometimes called a solo 401(k). In 2023, these plans allow you to make a $22,500 “employee” contribution ($29,500 if older than age 50) and then make “employer” contributions of 20% of your net income up to the plan contribution limit of $61,000.
While you only get one employee contribution no matter how many jobs or 401(k)s you have, the $61,000 limit is a per-plan limit. That means if you have an employee job with a 401(k) and do some work as an independent contractor, you can still open an individual 401(k) and just contribute the employer contribution to it.
Where Can I Open a Solo 401(k) Account?
Solid individual 401(k) plans can be easily opened at any of the large mutual fund or brokerage companies such as Vanguard, Fidelity, Charles Schwab, eTrade, or TD Ameritrade. While all of these plans are good plans with diversified, low-cost investments available, some plans offer features that others do not.
How to Set Up a Solo 401(k) and What Plan Features Should You Look For?
Be sure the individual 401(k) plan you choose has the features that are important to you, such as Roth contributions, IRA rollovers, or 401(k) loans. For example, some might not offer a Roth option while others do. If a 401(k) loan is important to you, Fidelity, Schwab, and Vanguard don't allow them with their plans, but it is an option with eTrade.
You will also need to get an Employee Identification Number from the IRS to open an individual 401(k), but this is free and only takes a few minutes online. You do not need to form an LLC or corporation to use an individual 401(k). By virtue of receiving a 1099, you are automatically a sole proprietor, and that is enough to start a plan.
If you are interested in investing in real estate or other non-publicly traded investments, consider a self-directed 401(k).
Self-Employed SEP-IRA
Some doctors, and even their accountants, consider using the slightly simpler SEP IRA instead, which has the same $61,000 total contribution limit. However, thanks to the employee contribution feature of an individual 401(k), you can hit the maximum contribution of $61,000 with a much lower income. In addition, using the i401(k) instead of a SEP IRA allows you to do a Backdoor Roth IRA since the balance of a SEP IRA is included in the required pro-rata calculation (explained below). Talance of an i401(k) is not.
Backdoor Roth IRA
Whether you are employed or self-employed, you can also contribute to a personal Backdoor (indirect) Roth IRA and—if you're married with sufficient income—a spousal Backdoor Roth IRA. These became permitted in 2010 when Congress began allowing high earners to do Roth conversions. Instead of a direct Roth IRA contribution, you first contribute to a traditional IRA, which is not deductible due to your high income, and then move that money to a Roth IRA.
There are still plenty of great retirement savings options if you are riding solo.
Since you never received a deduction, there is no tax cost for the conversion, and the end effect is the same as if you had contributed directly to a Roth IRA. Annual Roth IRA contribution limits for 2023 are $6,500 if younger than age 50 and $7,500 if older than age 50.
Be aware that due to the pro-rata rule, the conversion is only tax-free if you have no balance in a SEP IRA, a SIMPLE IRA, or a traditional IRA on Dec. 31 of the year of the conversion. If you do have one of those accounts, you may wish to roll it into a 401(k), such as your new individual 401(k), to facilitate future Backdoor Roth IRAs.
Like with a self-directed, individual 401(k), you can also have a self-directed Roth IRA and invest in real estate or similar private investments. Just keep in mind that if your investment is leveraged, you will be subject to Unrelated Business Income Tax in a self-directed IRA (but not a self-directed 401(k)).
Health Savings Account (HSA)
A health savings account (HSA) can also function as a stealth IRA, and it's an excellent account to use for retirement savings. Not only does it give you an upfront tax break and tax-protected growth like a 401(k), it also provides for tax-free withdrawals if the money is used for healthcare. This makes it the most tax-advantaged account available to the investor. These funds can be invested in mutual funds like a typical retirement account. The contribution limit for 2023 is $3,850 for individuals and $7,500 for families. If you end up not needing it for healthcare, you can withdraw the money penalty-free after age 65. However, you would need to pay taxes on that withdrawal, just like a 401(k).
Defined Benefit/Cash Balance Plan for Individual Contractors
Another option for independent contractors, although more rarely used, is a personal defined benefit/cash balance plan. This retirement account is best thought of as an extra IRA masquerading as a pension. It has higher expenses than an individual 401(k) due to a requirement for annual actuarial calculations, and it typically is not invested as aggressively. However, the contribution limits can be quite high, particularly for physicians in their 50s or 60s. It is an option worth exploring for someone interested in saving large amounts for retirement.
Taxable Brokerage Account
Investing in a nonqualified, taxable brokerage or mutual fund account for retirement is also an option. While the tax and asset protection benefits are much more limited, the additional flexibility can be a useful feature. Alternative investments, such as real estate, are also much easier to invest in outside of retirement accounts, and equity real estate can provide income that is tax-free—at least for a few years—thanks to depreciation.
Self-Employed Retirement Savings Options Summary
As you can see, an independent contractor has plenty of excellent options to use for retirement savings. While the main pillar should be an individual 401(k), remember that a Roth IRA, HSA, cash balance plan, and taxable account provides additional options.
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Are you self-employed? Which retirement accounts have you used to save for retirement? Comment below!
My wife will be starting her first full time job in October as a Rheumatologist. As part of her contract, the hospital has agreed to pay her student loan debt, to which she will be provided a 1099 as a forgiveness of that debt. If she receives a 1099 that is separate from her normal w-2 salaried job can we open a solo 401k assuming that the 1099 income will be considered “earned income”?
Thanks for any advice that can be provided concerning ways that we can do to plan to reduce our tax burden will be helpful.
It’s not forgiveness and yes, it’s taxable. It’s a lot like salary. No, you can’t open a solo 401k for that because I don’t think it is actually earned income. But if you’re paying payroll taxes on it, then perhaps it is earned income. At any rate, I’m not sure you can really justify opening a 401k for a business that will never have any more income and only got paid once, but it’s admittedly a gray area and you could push the envelope and I doubt anyone would say anything. Make sure the 1099 is made out to the EIN of the new business instead of your SSN to make it less gray.
Thanks for the input. A few follow up points/questions. I have asked posed this same question to my CPA and he thinks that there is justification for the solo 401k also. The payment will not be one time, it will be spread over a 5 year period, so at a minimum we will have 5 years in which a deduction of and additional $19,500 would make a pretty big tax difference. I can easily set up a Sole Proprietorship for her and request that the 1099 be made out to the business and EIN (assuming the hospital would be OK with doing this). Is there anything else that I’m missing? Basically the sole prop would have 1099 income of which there would be one deduction, which would be into the solo 401k. Any other items that I should think to address?
Thanks in advance
I think I’d be remiss if I didn’t recommend you get professional advice before doing this. I think it’s pretty gray. Don’t forget you only get one $19.5K employee contribution into all of your 401ks per year. Any other contributions must be employer contributions. So even if she gets $30K in forgiveness and you decide somehow that is really business income, you can still only contribute $6K to the individual 401(k) because she used up her $19.5K employee contribution at the main gig 401(k).
I understand completely and fully recognize that this specific example is living in the gray area. I completely forgot about the 20% cap of income, which would be $6k and not the full $19,500 as previously mentioned. Thank you for reminding me of that. Based on that fact, I’m only looking at $1800 in tax savings vs the amount of time/effort to get everything set up for the solo 401k.
She will have an avenue for 457b, so maybe we should consider that route for additional retirement savings and current tax savings. I understand there are a whole separate level of concerns with 457b, but maybe for us that would be the best alternative for additional retirement savings.
And you can always save in taxable. It’s not the end of the world. 10 of my 12 monthly retirement savings contributions these days go into taxable investments.
I’ve read a couple mixed statements about when the deadline is for creating and contributing to an individual 401k for 2019. Was it Dec 31st, 2019 or is it the current tax deadline of July 15, 2020? Any clarification is appreciated.
There are two deadlines. The first is when employee contributions must be in. It’s basically the end of the year but I think there is a couple of weeks of grace period, maybe even a month. The second is when employer contributions must be in and that’s your tax day, as late as October 15th with an extension.
I recently started working as a 1099 contractor (dentist) part time. I have an Employee Identification Number from the IRS that we have only ever used to file our taxes for our Nanny, a “household employee”.
After searching and searching, I cannot find any clear information as to if I can use the same EIN for both my nanny taxes and for my solo 401k. Can anyone shed light on this? Much appreciated!
I’d get a new one, just in case. It’s free, fast, and easy.
I wish is were that easy…but when you sign up for a EIN for a “household employee” per the IRS website it must be under a “Sole Proprietor”, so the only way I can get another EIN is if I do an LLC? I cannot have two EINs as a “Sole Proprietor”. Am I missing something obvious here? Thanks!
Why can’t you have two sole proprietor businesses? That’s silly.
I can have two sole proprietor businesses, but I can only have one sole proprietor EIN.
What happens if you sell one of the businesses?
My wife, who is a physician, is going to start as a supplemental staff and will not be eligible for benefits. Previously, she was employed as benefit eligible staff at a different facility and has 403b account through previous employer. I am also a physician and have 403b and medical/dental insurance for the family through my employment. We both have been contributing to backdoor Roth IRA accounts.
Since, she is going to be 1099 employee, what do you advise regarding retirement account set-up? We want to continue to contribute to our Roth IRA accounts.
The usual set up is
1. Individual 401(k)
2. Backdoor Roth IRAs
3. HSA (if using an HDHP)
4. +/- a Personal Defined Benefit/Cash Balance Plan
5. Remainder in Taxable
Lots of people just don’t save enough to get past 2 or 3.
And remember there is no such thing as a “1099 employee.” When you get a 1099, it’s because you are a separate business contracting with another business. Since it’s your business, you get to choose (and pay for) your own benefits.
As a 1099 physician with a PLLC, I cannot encourage others enough to open a cash balance plan. Together with a solo 401K, these plans maximize the amount you can put away pre-tax (at my age, over $300K per year). As you mention in your article, they are somewhat cumbersome to set up the first year, and they do have expenses associated with them (accountant, attorney, and actuary fees), but these are trivialized when you consider how much you save by putting this amount away tax-free.
Depends on plan and age. In your 50s, $200K+ is doable. In your 30s, it might be much less. My dumb plan is limiting me to just $17.5K right now.
Do you have anyone you would recommend to set up a cash balance/defined benefit plan? I am an orthodontist in my mid-40s and have been maxing out my self-directed 401k and backdoor roth, but would love to find any additional tax-benefit retirement options.
Here you go:
https://www.whitecoatinvestor.com/retirementaccounts/
For the individual 401K, which brokerage allows you to roll over old employer sponsored 401K plans?
Thanks!
Pretty much all of them. More info here:
https://www.whitecoatinvestor.com/where-to-open-your-solo-401k/
I was W-2 employed through the end of January of this year and deferred 23K into my company’s 403(b) for 2021 (I turned 50 this year). The hospital cut my department and I established my own practice. How much more can I put into a new 401k that I start this year with my private practice (3 employees/none highly compensated employees). Assume I participate in Safe Harbor contributions for my employees to max out my eligible amounts.
Maybe nothing, but way more info needed.
What relevant info do you need to answer the question? Happy to list whatever is needed. Thanks
Happy to provide whatever relevant info needed for you to answer my question.
Almost surely not enough to be worth putting in safe harbor contributions for your employees.
You can’t make another employee contribution.
You probably can’t do profit sharing contributions.
I’m not even sure you can set it up to do any sort of match for yourself since you can’t make another employee contribution for this year. I’d spend the next 6 months getting a study done of the practice to determine the best retirement plan for the practice- 401(k), SEP, SIMPLE, or nothing at all.
What relevant info do you need to answer the question? Happy to list whatever is needed. Thanks
Dr. Dahle,
I appreciate this article. I am still a little confused though and even if I do understand, I could use some advice. I am a resident with 4 jobs. My question is whether I should open a solo-401k and if so, how much I can actually contribute.
A) Resident job. W2. I contribute to a Roth 403b whatever the difference is between $19,500 and the contributions from job B ($14,100). Gross income is around $60k.
B) Moonlighting job. W2. I get a 5% match for contributing 9% of gross income. I contribute to the 401k in order to get match. Gross income is around $60k. So contributions are around $5400.
C) Moonlighting job. 1099. Gross income is around $50k.
D) Moonlighting job. W2. No 401k eligibility. Gross around $15k.
Total gross income should be around $185k. Also, I have already fully funded backdoor Roth IRA for this year. Job C should allow me to open a solo-401k.
If I understand this correctly, I can contribute as an employee the difference between $19,500 and my contributions from the 403b in job A (or put another way, the equivalent of the 401k contributions in job B ($5400)).
For the solo-401k employer contribution, I could contribute 20% of $50k or around $10k.
This would mean I could put around $15,400 total into a solo-401k. I would prefer to do this Roth as well, I believe. I already do all my investing with Vanguard, so it should be feasible.
I know this is a convoluted question but I would appreciate any insight you can give.
($50K-business expenses including employer half of payroll taxes)*20% = ~ $10K
You used up your employer contribution between jobs A and B so none of that can go into the solo 401k. You can’t use that $5400 in Job A and Job C’s 401k.
Can I max out a solo 401k and also do a backdoor Roth IRA?
Yes.