Retirement Savings Plan Options for the Self-Employed and Small Business Owners

Joe DowlingFebruary 2, 2017

Retirement Planning

According to the Bureau of Labor Statistics, 35% of the U.S. workforce consists of freelance contractors and that number is likely to increase as automation and technology continue to reduce payrolls.  Many self-employed individuals assume their retirement savings strategy is limited to an annual contribution to an IRA, which is limited to $5,500 in 2017 with a $1000 catch-up provision for savers over 50.  They don’t realize they can establish a retirement savings plan similar to one they may have if employed by a large corporation.

For the self-employed and other small business owners, awareness of creative and effective retirement savings vehicles is becoming increasingly important as the “retirement savings crisis” receives more media attention. As the ranks of these freelancers, contractors and other self-employed continue to swell, demand for savings strategies will increase. Additionally, the flexibility and accessibility of healthy saving options might entice professionals to “go it alone.”

SEP-IRA’s and Solo 401(K)’s are two popular plan design options.  Both have advantages and disadvantages in regard to set-up fees, contribution limits and flexibility.   For 2017, a self-employed person can contribute 25% of their pay into a SEP-IRA, up to a maximum of $54,000. However, if the business owner were to hire employees, they would be required to contribute the same percentage to eligible employees.

With a solo 401(K), like an employer-sponsored plan, an individual can defer $18,000 a year, or $24,000 if they are over 50. Additionally, up to 25% of pay can be deferred as a non-elective contribution. Total annual contributions max out at $54,000 as well.

The solo 401(K) has other compelling benefits and features.  The spouse of the 401(K) owner can participate in the plan. The business owner can include a loan provision in the Plan Document which provides liquidity and accessibility to the assets in the account. Although not recommended, account holders can lend themselves money if circumstances dictate, and pay themselves back at a defined interest rate. There is no income tax owed and no 10% penalty is applied as it would if the person took a distribution from an IRA.

Perhaps the biggest advantage of the plan is it can be established in combination with other retirement plan structures, including cash balance or defined benefit plans. These additional “sleeves” can help workers grow their retirement nest egg.

Many Baby Boomer business owners have spent their lifetimes re-investing profits in their companies at the expense of building up their retirement assets. Personal wealth is completely embedded in their business. If their business begins spinning off consistent cash flow, they may be able to start deferring more money into a retirement savings vehicle than traditional plan designs allow.

Enter the cash balance plan, which helps these savers accelerate retirement savings while reducing the tax burden on the business and business owner.  Cash-balance plans have high contribution limits that increase with age. Small business owners and principals over age 60 can defer over $200,000 a year in pre-tax contributions.  

Cash Balance Plans are a hybrid between Defined Benefit (DB) and Defined Contribution (DC) Plans, which combine the high contribution limits of traditional DB plans with the flexibility and portability of a 401(K).

According to Retirement Plan Services firm Kravitz, the cash balance plan market, which topped $1 trillion in total invested assets in 2016, is growing at a rapid pace. Newly established cash balance plans showed a year-over-year 19% increase, significantly outpacing the 401(K) market, which showed just a 2% increase in new plans. The growth is being fueled by a number of factors. Rising federal, state and local tax rates are compelling business owners to take advantage of tax deductions for contributions. The retirement savings crisis, particularly the Baby Boomer generation’s lack of retirement preparedness, is motivating business owners to maximize their contribution options. And the higher savings rates these combo plans provide negates the need to take on excessive investment risk to build a sufficient retirement nest egg.



Bureau of Labor Statistics 

Kiplinger – The Pros and Cons of Cash Balance Pension Plans

Employee Benefit Adviser – Rise in self-employed boosting solo 401(k), SEP IRA usage

2015 National Cash Balance Research Report