Self-Employed Retirement Savings Options Explained
By Ashlyn Brooks
From Kiplinger’s Personal Finance
Figuring out the most effective way to save for retirement can be confusing for anyone, but for the self-employed, the challenge is often amplified. Without the options that traditional employers provide, freelancers, consultants, and other solo entrepreneurs must carve their own path.
For most, the choice boils down to two plans: the solo 401(k) and the Simplified Employee Pension (SEP) IRA. Here’s the rundown on both plans:
Solo 401(k)
Often referred to as a solo-k or individual 401(k) plan, the solo 401(k) is tailored specifically for businesses in which the only employee is the owner (and possibly their spouse). The contribution limits are the same as a traditional 401(k), but the owner can contribute as both the employer and the employee, totaling up to $58,000 in 2021 for those under 50, and $64,500 for those 50 and over.
The employee contribution limits are the same as a traditional 401(k) at $19,500 in 2021, with an additional $6,500 catch-up contribution available for those 50 and over. The employer contribution is also capped at 25% of the business’s net income.
The plan is easy to set up and administer and can be particularly appealing for those who expect their income to fluctuate from year to year, as they can make contributions as their business cash flow allows. It also offers the potential for a Roth contribution and the ability to take out a loan from the plan.
SEPIRA
The SEP IRA is the other major retirement savings vehicle for the self-employed. Unlike the solo 401(k), the SEP IRA is easier to set up and has no annual filing requirements.
This makes it a good fit for those who want a simple and low-cost retirement savings option. In a good year, business owners can contribute up to 25% of their net earnings from self-employment, up to a maximum of $58,000 in 2021.
In a bad year, they can choose not to make a contribution at all. The SEP IRA also allows them to make contributions later than the solo 401(k) plan—as late as their tax filing deadline, including extensions.
The SEP IRA does not allow for a Roth contribution, and loans are not permitted. It also has a unique provision that requires the business owner to contribute the same percentage of salary to employees’ accounts as they do to their own account. However, they don’t have to contribute to employees who are under 21 or who have worked for the business for less than three of the past five years.
The Bottom Line
While there are other retirement savings options available to the self-employed, the solo 401(k) and SEP IRA are among the most popular choices. It’s essential to weigh the benefits and drawbacks of each plan to determine which best fits your business’s unique needs. Consulting with a financial advisor can also provide valuable insight to make an informed decision.
