Retirement plans for the self-employed

Are self-employment retirement contributions tax deductible?

There are a few different tax-deferred or tax-deductible retirement accounts. Tax-deferred means you pay federal income taxes on this savings plan only when you withdraw money from it, rather than pay taxes on the contributions and earnings upfront. Tax-deductible means you can deduct your contributions on your taxes. The difference between them depends on whether you're self-employed or work for a company with more or less than 100 employees.

You have numerous options and avenues available, some of which are like—but with key differences—some employer-sponsored plans, including SEP-IRAs, solo 401(k)s, SIMPLE IRAs, and traditional IRAs.

In this piece, we’ll break down the differences between each of these and potential tax benefits inherent in them.

An individual retirement account (IRA) is a special type of investing account that can provide unique tax advantages while helping you save for the future. IRA contributions, simply put, are money you put into an IRA.

There are several different types of IRA available, each with different tax benefits. All four allow you to make contributions every year you meet IRS eligibility requirements. Those requirements can vary from account to account and year to year.

The four most common IRAs are:

• Traditional IRA
• Roth IRA
• SEP-IRA (SEP is short for Simplified Employee Pension)
• SIMPLE IRA (SIMPLE is short for Savings Incentive Match Plan for Employees)

Traditional IRA contributions may be tax deductible, helping you reduce your taxable income and potentially increasing the size of your refund. Roth IRA contributions are not tax deductible, but your savings in a Roth IRA can grow tax free.

You can only take part in a SEP-IRA or SIMPLE IRA if you are self-employed, or your employer offers one. Their details and tax benefits are somewhat complicated.

Simplified Employee Pension (SEP) IRA for self-employed

When you are self-employed, you can contribute to your own SEP-IRA as an employer, treating yourself as an employee. In 2023, the employer contribution is $66,000 or 25% of your compensation as an employee, whichever is lower.

Savings Incentive Match Plan for Employees (SIMPLE) IRA for self-employed

On the other hand, the 2023 contribution limit for a SIMPLE IRA is $15,500. These limits change annually, so work with your tax professional on the latest limits.

Traditional IRA for self-employed

Another possible option for you if you’re self-employed is looking into an IRA. An IRA is probably the easiest way for self-employed people to start saving for retirement. There are no special filing requirements, and you can use it whether or not you have employees.

For 2023, the limit is $6,500 saved pre-tax per year, or $7,500 if you’re aged 50 or older. Withdrawals in retirement can be fully or partially taxable. It’s important to note that these are individual accounts, so there’s no matching contribution as is often the case when you’re a full-time or W-2 employee.

An IRA is one of the easiest avenues for self-employed people to start saving for retirement. There are no special filing requirements, and you can use it whether you have employees.

Roth IRA for self-employed

You may have heard of Roth IRAs. The tax treatment of a Roth IRA might be good for you if it’s early days for your business (read: you’re not making much money). In that case, your tax rate is likely to be higher in retirement, when you’ll be able to pull that money out tax free.

What’s more, Roth IRAs also don't have required minimum distributions, and ROTH IRAs can be transferred to heirs, tax-free.

Again, there’s a crucial note here: The Roth IRA has income limits for eligibility; those who earn too much can't take part. You can work with your Tax Pro on what may be the best option for you and your specific situation.

401(k) for self-employed

It’s true that making contributions to a traditional 401(k) savings plan, also known as a retirement plan, could help lower your tax bill, as well as set you up for a more comfortable future. But let’s take a deeper look at how investing in these plans could lead to reducing your taxable income. 

With a tax-deferred 401(k) plan, you’re setting aside money from your pay before federal and state income taxes are withheld. Putting money from your gross pay into a traditional 401(k) lowers your taxable income so that you pay less taxes now.

For example, let’s say your salary is $35,000 and your tax bracket is 25%. Contributing 6% of your salary ($2,100) lowers your taxable income to $32,900, saving you $525 in taxes today. 

Not only are you saving for your retirement with these plans, but you’re saving on taxes today, too.  

Solo 401(k) for self-employed

Meanwhile, a one-participant 401 (k) is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” It is generally the same as other 401(k) plans. This plan can be used when it is only you, and your spouse, working in your business, because there are no employees other than your spouse who work for the business, it is exempt from discrimination testing.

How to report retirement contributions on tax return in 2024

If you have a retirement plan where you have more control over the timing and amount of your contributions, such as a Roth IRA, you will receive a Form 5498 from the brokerage where you hold the account.

What is IRS Form 5498?

Form 5498 is an information form issued to owners of traditional and Roth IRAs, SEP (simplified employee pension), and SIMPLE (savings incentive match plan for employees) plans to report activity within these accounts. While predominantly known for reporting plan contributions, Form 5498 is also used to report Roth conversions and if any repayments were made to the account if you had prior distributions.

Additionally, Form 5498 reports the amount of required minimum distributions (RMD) you had during the year. The RMD must start by age 72 to avoid costly penalties. If you inherited the IRA, you are also subject to the RMD, and the amount withdrawn will be shown on Form 5498.

You’d then use Form 8606 to report:

• Nondeductible contributions to traditional IRAs
• Distributions from traditional, SEP, or SIMPLE IRAs, if you have ever made nondeductible contributions to traditional IRAs
• Conversions from traditional, SEP, or SIMPLE IRAs to Roth IRAs
• Distributions from Roth IRAs

There are other possible forms and necessary steps to take, so work with a Tax Pro who can make sure you’re doing all you need to do as you file your 2023 taxes in 2024.

At the end of the day, there are many options for you to save for retirement as a self-employed person. Work with your Tax Pro to discuss what may be best for you. Find a local tax professional today.

About the Author

Mark Steber is Senior Vice President and Chief Tax Information Officer for Jackson Hewitt. With over 30 years of experience, he oversees tax service delivery, quality assurance and tax law adherence. Mark is Jackson Hewitt’s national spokesperson and liaison to the Internal Revenue Service and other government authorities. He is a Certified Public Accountant (CPA), holds registrations in Alabama and Georgia, and is an expert on consumer income taxes including electronic tax and tax data protection.

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