Choosing a Retirement Plan for Independent Contractors

Retirement plan

You Have Great Options!

According to a recent Forbes article, 13% of the US workforce now consists of independent contractors.  And this percentage will continue to grow, both as employers remain reluctant to add permanent headcount and employees seek more flexible, self-directed work arrangements.

Are you among or thinking about become a part of this growing demographic?  If so, there are a number of great retirement plans for independent contractors.  First I’ll cover key facts related to each type of plan and then I’ll talk through some specific scenarios to get you started on making a decision.


The SIMPLE IRA lives up to its name if you’re a solo independent contractor.  You can contribute $12,500 per year or $15,500 if you’re over 50.  These contributions far exceed the $5,500 – $6,500 you can park in a traditional IRA.

If you have employees, things get a little more complicated.  You’re required to follow one of two approaches in terms of employer contributions:

  1. Match each employee’s salary reduction contribution on a dollar-for-dollar basis up to 3% of their salary.
  2. Make non-elective contributions of 2% of each employee’s salary to each employee’s plan, whether they are choosing to contribute to the plan or not.


The big advantage of the SEP IRA is the high contribution limits.  You can contribute up to 25% of your pay, up to a maximum salary deferral of $53,000 a year.

The big disadvantage is that whatever percentage of your pay you’re contributing to your plan, you’ll need to do the same for all of your employees.  So, if you’re contributing 10% for yourself, you’ll need to contribute 10% of each of your employees’ salaries as well.  If you’re on your own, this is a non-issue, but if you have employees working for you, this gets expensive in a hurry!

The Solo 401(k)

Solo 401(k)’s allow you to make big contributions in a hurry.  You can defer your first $17,500 in earnings right into your plan.  Then you are allowed to contribute an additional 25% of your salary, up to a maximum total contribution of $53,000.  Because of the initial salary deferral feature, you can get to the $53,000 limit at a lower income level than the SEP IRA plan.

An added bonus of these plans is that you can borrow against your plan contributions, should you need money someday to expand your business.

The downside of the solo 401(k) is the administrative hassle.  The paperwork required is more cumbersome and there are additional longer-term requirements.  An example of this is that an annual statement is required once the plan balance hits $250,000.

Traditional & Roth IRA’s

While not specifically for independent contractors, these plans are options as well, particularly if you’re just starting out and can only make modest contributions initially.

For both Traditional and Roth IRA’s, annual contributions are capped at $5,500 or $6,500 if you’re over 50.

Traditional IRA contributions are made in pre-tax dollars, while Roth IRA contributions are in after-tax dollars.

The big advantage of the Roth is that your contributions (before any investment returns) can always be withdrawn tax-free and penalty-free.

Earnings are a different story from a tax and penalty standpoint.  These withdrawal rules are more complex and depend whether or not you’ve had the account for more than 5 years as well as whether you meet the allowable circumstances for an early withdrawal.

How Do I Decide?  [Geek Alert!]

One of the best ways I can break this down is for me to remember back when I used to have to program in FORTRAN in engineering school.   Programs would often contain “If….Then” statements to control what the computer did.

I spent many a night until 2:00 AM in Penn State’s computer lab trying to debug my programs and get them to work.  We’ll keep things much simpler here with a few If….Then statements related to retirement plans to help you work through the options.

If You’re Contributing Smaller Amounts

Scenario 1

IF            You want to make an annual contribution of $5,500 or less

AND       Want to shield all of the money from taxes until retirement

AND       Won’t need the money until retirement

THEN     Consider opening a Traditional IRA

Scenario 2

IF            You want to make an annual contribution of $5,500 or less

AND       Want tax free growth of the earnings

AND       Want the flexibility of being able to withdraw your contributions at any time

THEN     Consider opening a Roth IRA

If You’re Contributing Moderate Amounts

IF            You want to make contributions up to $12,500 a year

AND       Want to shield all of the money from taxes until retirement

AND       You might hire employees some day

THEN     Consider opening a SIMPLE IRA

If You’re Contributing Larger Amounts

Scenario 1

IF            You want to make contributions up to $53,000 a year

AND       Want to shield all of the money from taxes until retirement

AND       Don’t have plans to hire any more employees

THEN     Consider opening a SEP IRA

Scenario 2

IF            You want to make contributions up to $53,000 a year

AND       Want to get to this contribution maximum as quickly as possible

AND       Want to be able to borrow money from your account

AND       Don’t mind the administrative hassle

THEN     Consider opening a Solo 401(k)

Your Assignment:

These are just a few of the possible retirement planning scenarios for you as an independent contractor.  This article is meant to get you started with your decision; however as always, these general recommendations may or may not apply to your unique circumstances.

Weigh your options in light of the contributions you can make now, what you think you’ll be able to contribute in the future and whether or not you’ll remain a solopreneur or will hire employees at some point.

Whatever your decision, make it a point to choose a plan and get started.  These are some outstanding options for you as an independent contractor to help you plan for a great retirement!

Originally published on Nerdwallet.