3 Types of Retirement Plans: When You’re Self-Employed, Which 401(k) is Right for You?

Retirement planning can be complicated when you do have access to an employer-sponsored retirement plan. There are decisions to make, options to choose and deadlines to meet. But what if you don’t have access to a plan? Where do you even start?

At Scarborough Capital Management, we get a lot of questions about retirement planning from those who own or work for a small business, or are gig workers or independent contractors. The good news is, you can set up your own plan to save for retirement. Depending on your circumstances, you may qualify for either a Solo 401(k), a SIMPLE 401(k), or a Small Business 401(k).

A Solo 401(k) is for the self-employed who have a verifiable income and can show that they, and not an employer, are the source of income. With a Solo 401(k), you have the option to choose either a Traditional 401(k) or a Roth 401(k) plan.

The “SIMPLE” part of a SIMPLE 401(k) is an acronym for Savings Incentive Match Plan for Employees of Small Employers. It combines the features of the more familiar SIMPLE IRA (Individual Retirement Account) with the Traditional 401(k) plan.

An Association Retirement Plan (ARP) is designed for those who own a small business or work for a small business and don’t have access to a retirement plan at work. An ARP, which is a defined-contribution retirement account, allows small businesses in the same geographic area to join forces to create a group 401(k).

So, which plan could make sense for you?

Scarborough Capital Management breaks down the benefits and drawbacks, as well as the eligibility requirements, of each.

 

Have questions about your retirement? Get the conversation started! Schedule a no-obligation consultation with the team at Scarborough Capital Management.

 

Solo 401(k)

Also known as an Independent 401(k) plan, a Solo 401(k) is a tax-advantaged retirement account. To be eligible, you must be responsible for your own income and able to show earned income through tax records. If you are a sole proprietor, independent contractor or gig worker, you may qualify.

If you’re eligible and you decide to go with a Solo 401(k), you’ll have to put your plan in writing, and specify whether you intend to open a Traditional or Roth 401(k).

With a Traditional 401(k), your contributions are made with pre-tax money, meaning you’ll pay income tax on withdrawals and earnings later on, when your tax rate might be lower than when you invested the money initially. With a Roth 401(k), you contribute after-tax dollars and withdrawals and earnings are tax-free in retirement.

(For more information on the difference between Traditional and Roth 401(k)s, read our recent blog post: A Little 401(k) Education: Roth Versus Traditional. Contact us to review what each option looks like based on your situation.)


Another benefit of a Solo 401(k) is that these plans include higher contribution limits than most other retirement plans, because you can contribute as both an employee and as an employer. For 2021, the maximum you can contribute as an employee is $19,500, plus an additional $6,500 catch-up contribution if you’re 50 or older. The maximum you can contribute as an employer is 25 percent of your income, up to a maximum of $38,000. This means you can put as much as $64,500 into a Solo 401(k) this year.

SIMPLE 401(k)

A SIMPLE 401(k) plan is available to those whose employers have 100 or fewer employees, who are at least 21 years old, and who have been with the employer for at least one year, earning at least $5,000.

Employees contribute pre-tax funds to a SIMPLE 401(k) from their paychecks, much like with a Traditional 401(k), although the maximum contribution limit is usually lower than that of a Traditional 401(k). In 2021, the most an employee can contribute to a SIMPLE 401(k) is $13,500, plus an additional $6,500 catch-up contribution for those over the age of 50.

The biggest benefits of this type of plan are that employees are immediately 100 percent vested, and that the IRS requires employers to contribute. Employers must match up to 3 percent of an employee’s pay, or make a non-elective contribution of 2 percent, regardless of whether, or how much, the employee contributes.

Employees can keep a SIMPLE 401(k) even if they switch jobs without losing whatever money is in their accounts.

Once eligible for distributions, you can withdraw as much as you want, even the entire account balance, but until you reach the age of 59-½, any withdrawals you make will be subject to a 10 percent penalty.

One caveat: If an employer offers a SIMPLE 401(k), IRS rules state that the employer may not offer any other types of retirement plans to those covered by the SIMPLE 401(k).

Association Retirement Plans (ARP)

In 2019, the U.S. Department of Labor established a rule to make it easier for small business owners to offer retirement plans for their employees, to provide for the estimated 38 million Americans who don’t have access to an employer-sponsored retirement savings plan. Association Retirement Plans (ARP) were created as a new kind of Multiple Employer Plan (MEP). MEPs are limited to employers with something in common, like being in the same industry or having common ownership. An ARP allows companies that are in the same geographic area regardless of industry, or in the same industry regardless of their physical presence, to form a 401(k) plan together.

An ARP can be offered and administrated by a group, like a chamber of commerce, or a Professional Employer Organization (PEO). These organizations serve as the single employer for all of the employees participating in the ARP 401(k) plan, and are responsible for sponsoring and administering the plan for all of the member companies. The organization must act in the best interests of the member companies.

Which is Right for You?

Still not sure which type of retirement plan would suit you best, or don’t know where to start in setting one up? There is much more to learn and consider about each of these 401(k) options. If you have questions or concerns, schedule a conversation with the financial advisors at Scarborough Capital Management to determine the options that are right for you.

Scarborough Capital Management is headquartered in Annapolis, Maryland and helps clients nationwide. One of our specialties is 401(k) plan management. Retirement planning can be complicated. Schedule a conversation and take the first step in working toward your financial goals.

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