Best retirement accounts for entrepreneurs in 2023

/

Retirement accounts can be a fantastic tax strategy tool for entrepreneurs. When you first start your business, you may want to check out the ROTH or Traditional IRA account.

But, eventually, you’ll max out the annual contribution limits. As you become a high-earner, talk to your wealth manager about the SEP-IRA and Defined Benefit Plan.  

Below are the six best retirement plans for freelancers, small business owners, and entrepreneurs.

The six best retirement plans for entrepreneurs

1. Solo 401(k)

 The Solo 401(k) is also known as a one-participant 401(k) plan. It is for a business owner with no employees. It can cover you as the business owner and your spouse if they work for the business. These plans have the same rules and requirements as any other 401(k) plan. The taxes are similar to the 401(k) plan in that it is tax deductible the year of the contribution, the interest grows tax free, and you are taxed on the withdrawals.

Contribution limits 

As a business, you wear two hats under this plan: employee and employer. You can contribute to the plan under both hats. 

  • Under the employee hat you can contribute up to 100% of your compensation (i.e. earned income) up to the annual contribution limit. This is known as elective deferrals.

  • Under the employer hat you can contribute up to 25% of compensation as defined by the plan

 The total contributions to the account (not counting catch-up contributions) can not exceed $66,000 in 2023. If you are 50 or older the maximum contribution limit is $73,500 in 2023.

2. Traditional IRA

With the Traditional IRA, there is an upfront tax deduction. 

When you make a contribution to a traditional IRA, the amount of your contribution reduces your taxable income for the year. For example, if your income is $70,000 and you contribute $6,000 to a traditional IRA, then your taxable income that year will drop to $64,000, assuming you qualify for the tax deduction.

Contribution limits 

The annual limit for 2023 is $6,500, or $7,500 if you're age 50 or older.

Additional notes

  • If you freelance and work at a larger company, you can have an IRA and a workplace 401(k) plan

  • Investments grow tax-deferred. You are only taxed on gains once you withdraw.

  • Early withdrawals may be taxed as income and assessed a 10% penalty.

3. Roth IRA

The Roth IRA is similar to the Traditional but with opposite tax advantages. With this option, you pay taxes on the amount you contribute but once you withdraw it from the account, you do so tax-free. 

Similar to the traditional, the interest in a Roth IRA grows tax-free.

In 2023, the annual contribution limit for the Roth is the same as the traditional IRA:

  • Under age 50: $6,500

  • Age 50 or older: $7,500

If you contribute to both a Roth IRA and a Traditional IRA, the combined annual limit is $6,500 (or $7,500 if 50 or older).

4. SEP-IRA

A SEP-IRA is a simplified employee pension IRA. Contributions are tax-deductible, and investments grow tax-deferred until retirement. At this point, it will be taxed as income.

This plan is best for freelancers, independent contractors, or small-business owners with few or no employees. If you have employees, this plan requires equal contributions as a percentage of compensation. For instance, if you contribute 15% to your plan, you must also contribute 15% to each employee.

Contribution limits

These limits are much higher, up to $66,000 in 2023 or up to 25 percent of their business earnings or compensation, whichever is less.

You can combine a SEP IRA with a traditional or Roth IRA.

5. SIMPLE IRA

The SIMPLE IRA is best for larger businesses with up to 100 employees. Contributions are deductible, but distributions in retirement are taxed. Contributions made to employee accounts are deductible as a business expense. Unlike the SEP IRA, the contribution responsibility isn’t solely on you as the business owner.

Contribution limit:

Up to $15,500 in 2023. If you are over 50, you can contribute up to $19,000.

6. Defined Benefit Plan

The Defined Benefit Plan is best for a freelancer with no employees, who have a high income and wants to save a lot for retirement on an ongoing basis. Contributions are generally tax-deductible, and distributions in retirement are taxed as income. An actuary must figure out your deduction limit, which adds an administrative layer.

Contribution limit

This is calculated based on the benefit you’ll receive at retirement, your age, and expected investment returns. In other words, the limit is very high.

The tax savings can be enormous with this plan, but it is expensive to administer and maintain.