It's great being your own boss — until you have to wade through the alphabet soup of SEP IRAs and other retirement plans. Whether you're a full-fledged small-business owner, have a side hustle or receive 1099's as a freelancer or gig worker, there are several smart ways to save for retirement specifically designed for the self-employed.
Here's a comparison of two popular self-employed retirement savings plans: the solo 401(k) and the SEP IRA. See which option is right for your business and retirement planning needs.
SEP IRAs: What is a SEP IRA and how much can you contribute?
A Simplified Employee Pension IRA (SEP IRA) is a retirement account for anyone who is self-employed, owns a business or earns freelance income. A big advantage for small businesses is the low overhead; SEP IRAs do not have the same start-up and operating costs as a conventional retirement plan.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
SEP IRAs are available for a variety of small-business types, including sole proprietorships, partnerships, limited liability companies, S corporations and C corporations. You don’t even technically need to have an established business to open a SEP IRA. Anyone who has self-employed income can open a SEP IRA, including freelancers and gig workers who aren’t considered employees.
Who can contribute: An eligible employee, including a self-employed person, is an individual who meets all the following requirements: has reached age 21, has worked for the employer in at least three of the last five years and received at least $750 in compensation for 2024.
Maximum Contribution: The maximum amount an employer or self-employed person can contribute to a SEP IRA for 2024 is the lesser of $69,000 in 2024, or up to 25% of compensation or net self-employment earnings, with a $345,000 limit on compensation that can be used to factor the contribution.
Contribution deadline: Contributions must be made by the tax filing deadline or extension of the employer's return.
How to open a SEP IRA:A SEP IRA can be opened at many online brokers. You can set up a SEP for a year as late as the due date (including extensions) of your business income tax return for the year you want to establish the plan. You can establish and fund a plan for tax year 2024 up until your income tax filing deadline in 2025.
Tax treatment. Contributions are tax-deductible, including those made to employee accounts. You can deduct the lesser of your contributions or 25% of compensation, subject to the compensation cap ($345,000 in 2024). If you’re self-employed, your deduction is capped at 25% of your net self-employment income.
Calculating contribution limits for a SEP IRA plan
If the IRS considers the employees eligible to participate in the plan, an employer must contribute on their behalf, and those contributions must be an equal percentage of compensation to their own. This rule requiring equal contributions as a percentage of compensation is why a SEP IRA is generally best for self-employed people or small-business owners with few or no employees.
For 2024, employer contributions to an employee's SEP-IRA cannot exceed the lesser of $69,000 or 25% of the employee's compensation or net self-employment earnings, with a $345,000 limit on compensation that can be used to factor in the contribution. In this context, net self-employment income is net profit less half of your self-employment taxes paid and your SEP contribution.
Elective salary deferrals and catch-up contributions are not permitted in SEP plans.
Solo 401(k): What is a solo 401(k) and how much can you contribute?
One may be the loneliest number, but it can pay off with a solo 401(k); it is similar to a standard 401(k) except that you are the only person in the plan, with some exceptions.
A one-participant 401(k) plan is sometimes called a solo 401(k), solo-k, uni-k or a one-participant k. This plan isn't new and it has the same rules and requirements as any other 401(k) plan. What is different is that this 401(k) plan covers a business owner with no employees, or that person and his/her spouse.
Who can contribute: A self-employed business owner with no employees or a gig worker participating in an employer’s 401(k) who also has a side business.
Maximum Contribution: The maximum amount a self-employed individual can contribute to a solo 401(k) for 2024 not counting catch-up contributions for those age 50 and over, cannot exceed $69,000 for 2024. Individuals 50 and older can add an extra $6,500 per year in "catch-up" contributions, bringing the total to $75,500. Whether you're permitted to contribute the maximum, though, will be determined by your self-employment income.
Contribution deadline: Contributions must be made by the tax filing deadline or extension of the employer's return.
How to open a solo 401(k): A solo 401(k) can be opened through most online brokers and requires a valid Employer Identification Number (EIN). Once the plan balance is $250,000 or more, you must file an annual report on Form 5500-SF with the IRS at the end of a given year.
Calculating contribution limits in a one-participant 401(k) plan
Business owners can legally 'double-dip' and make contributions as an employee and employer to a solo 401(k) plan. The owner can contribute both elective deferrals and the employee nonelective contribution to their solo 401(k).
- Elective deferralsup to 100% of compensation (“earned income” in the case of a self-employed individual) up to theannual contribution limit of $23,000 in 2024.
- Employer nonelective contributionsup to 25% of compensation as defined by the plan, or for self-employed individuals up to 25% of net earnings.
Computing the limit for nonelective contributions is simple. When figuring the contribution limit, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both one-half of your self-employment tax and contributions for yourself.
The limit on compensation that can be used to factor your contribution is $345,000 in 2024.
SEP IRA vs. solo 401(k) — which is better?
At first glance, these plans may seem similar. But dig down into the weeds, and you'll find differences that could add up over the years. The solo 401(k) plan might be a better fit for side hustlers or part-time gig workers since you can borrow from the plan if you get in a jam, you can save at a faster rate, and you can invest in a company's 401(k) plan if you also have a regular job. On the other hand, if there's any possibility you might hire an employee, a SEP IRA is a better bet.
Why a SEP IRA may be the better choice:
Easier to administer: SEP IRAs have the same contribution limits but no annual reporting to the IRS.
Flexibility: You don't have to commit to contributing every year. You can reduce contributions in lean years and increase contributions when profits are up.
Optional Roth feature is allowed. The Secure Act 2.0 allows employers to offer a Roth feature but is not required to do so. You are now able to designate Roth treatment to SEP contributions. This change is recent and there are still many issues that need clarification.
Why a solo 401(k) may be the better choice:
Self-employed people may be able to save more in a solo 401(k) than they can in a SEP IRA. Solo 401(k)s let you make both employee and employer contributions, meaning you can contribute up to $23,000 for 2024 (or $30,500 if you're 50 or older) as an employee, even if that is 100% of your self-employed earnings for the year, and you can also contribute 20% of your net self-employment income. Your total contributions can't exceed your self-employment income for the year, up to a total of $69,000 for both types of contributions (or $75,500 if age 50 or older).
Maximize your savings opportunities: If you work for a company with a retirement plan and have a freelance income, contribute to both. But keep in mind that if you’re side-gigging, employee 401(k) limits apply by person, rather than by plan. That means if you’re also participating in a 401(k) at your day job, the limit applies to contributions across all plans, not each individual plan.
Tax advantages: You can opt for the traditional 401(k), and take a deduction for contributions and reduce your income. The alternative is the Roth solo 401(k), which offers no initial tax break but allows you to take distributions in retirement tax-free.
Choosing between a traditional or Roth solo 401(k) is part guess work. In general, a Roth is a better option if you expect your income to be higher in retirement and/or you expect tax liability to be higher in the future. You should take the deduction now if you think your income will go down in retirement, or you expect tax liabilities to remain the same or lower.
Don't forget to factor in how your income in retirement will impact if you are subject to the income related monthly adjustment amount (IRMAA) for Medicare Parts B and D. Distributions from Roth accounts are generally not considered taxable income and don't affect your IRMAA liability.
Spousal exception to the no employee rule: A spouse can be added to the solo 401k plan whether they act as a W-2 employee, or an owner in the business. This effectively doubles your solo 401k contribution limits for your household. Your spouse can either open their own solo 401k plan separate from yours, or get added to your existing plan with separate bank and brokerage accounts.
Swipe to scroll horizontally
| SEP IRA- Pros | Solo 401(k)- Pros | SEP IRA- Cons | Solo 401(k)-Cons |
|---|---|---|---|
| Pro: Easy to set up and administer | Pro: No age or income restrictions, but must be a business owner with no employees | Con No catch-up contribution for savers 50 or older | Con: "No employee" requirement may not be viable as your business grows |
| Pro: New Roth contributions (optional) | Pro: Additional catch-up contribution of $7,500 for those 50 or older | Con Required proportional contributions for each eligible employee if you contribute for yourself | Con: Contributions must be "Substantial and recurring" this means you must make contributions somewhat regularly for the account to remain active |
| Pro: You don't have to commit to contributing every year | Pro: Can contribute in your capacity as an employee and an employer (elected deferral) | Con: Elective salary deferrals and catch-up contributions are not permitted in SEP plans | Row 2 - Cell 3 |
| Row 3 - Cell 0 | Pro: Can add your spouse if they are an employee or part owner | Row 3 - Cell 2 | Row 3 - Cell 3 |
Bottom line
You can't go wrong investing in a SEP IRA or solo 401(k). They both offer tax-deferred growth and an opportunity to make Roth contributions. Contribution limits for both types of accounts are generous and neither creates a large administrative burden.
The solo 401(k) would be my choice if I had no employees. The ability to make catch-up contributions gives this account a slightly higher contribution limit and you can add your spouse, if their participation meets IRS requirements, and double your maximum contributions.
A SEP IRA has many of the great features of a solo 401(k) and allows employees to participate making it a great option for small business owners. The ability to lower or forgo contributions when profits are down gives an employer more flexibility to respond to market conditions.
Related Content
- The Average 401(k) Balance by Age
- SEP IRA Contribution Limits for 2024
- Higher IRA and 401(k) Contribution Limits for 2024
- The Problem With 401(k) Catch-Up Contributions for 2024
