Retirement planning for the self-employed: How to choose between a solo 401(k) and SEP IRA
So you’ve decided to ditch the corporate job and join the self-employed crowd. Congratulations! You can set your own hours, implement your own strategy, and be your own boss. But does that mean you have to sacrifice the retirement savings plan?
Nope.
As an independent contractor, freelancer, gig economy stalwart, chief-cook-and-bottle-washer, or whatever you call yourself, you can choose between two main retirement plans: the solo 401(k) and the SEP IRA. Which self-employed retirement savings plan is right for you depends on your needs.
Key Points
- A SEP IRA works like a traditional IRA, customized for freelancers and other self-employed people.
- A solo 401(k) is like a traditional 401(k), but it’s only for a business owner with no employees, or a business owner and spouse.
- Both allow savers to sock away the same amount of money, but the specifics differ slightly.
What to know about a SEP IRA
SEP stands for simplified employee pension plan; it works like a traditional IRA customized for freelancers. Contributed funds are tax deductible and grow tax deferred until retirement. The SEP is particularly useful for gig workers who may have a traditional 401(k) at their main job, but want to save money for retirement that they earn in their side job.
SEP pros
- Set aside up to 25% of your business’s net income (after deducting one-half of your self-employment tax and contributions to your own SEP), up to $69,000 for 2024.
- Simple to set up and maintain.
- Contribute to employees’ retirement if your business grows.
SEP cons
- No “catch-up” contributions for people over 50.
- No Roth version available.
- Employers who contribute to employee SEP IRAs must give money equally, including to themselves.
SEP IRA plans are subject to the same rules as traditional IRA plans when it comes to withdrawals. SEP IRA holders will pay taxes on withdrawals and will incur a 10% penalty for early withdrawals. There are also required minimum distributions from age 72.
What to know about a solo 401(k)
Sometimes called a solo-k, uni-k, or one-participant k, a solo 401(k) plan is a traditional 401(k) covering a business owner with no employees, or a business owner and spouse. These plans act like a typical 401(k): You get tax breaks and tax-deferred growth, and unlike a SEP IRA, you can open a Roth solo 401(k). You can also take a loan out of a solo 401(k) plan, unlike a SEP IRA.
Independent contractors can make contributions as both an employee and an employer:
- Contribute up to $23,000 in 2024 as your employee deferral, and an extra $7,500 for people over 50 as a catch-up contribution.
- As noted earlier, contribute up to 25% of your business’s net income (after deducting one-half of your self-employment tax and contributions to your own SEP), for a total account value—that includes your employee portion—of $69,000 in 2024 ($76,500 for those over 50).
Unlike the SEP IRA, which limits contributions to 25% of income, the solo 401(k) does not place a percentage of pay on the employee contribution. That allows you to max out the employee part, and contribute as an employer, which could let you add more to your retirement plan.
Here’s an extremely simplified example:
- Jane, 51, made $100,000 in 2024 as a freelancer and contributed 25% to her SEP IRA, or $25,000, hitting the SEP IRA income limit.
- Sally, also 51, also made $100,000, but she has a solo 401(k). Sally contributed $30,000 to the employee part of her 401(k) using her over-50 catch-up contribution, and another $25,000 as her employer limit, for a total of $55,000 (under the IRS limit for her plan, but much more than Jane’s contribution).
If you choose a solo 401(k) and your business grows beyond you and your spouse, remember that you can’t add another employee to the plan. If you own two businesses or work a second job, your limits are by person, not by job.
| At a glance as of 2024 | SEP IRA | Solo 401(k) |
|---|---|---|
| Allows catch-up contributions | No | Yes |
| Maximum contribution | $69,000 | $69,000 (plus $7,500 catch-up) |
| Contribution rates | Up to 25% of income | Employee contribution up to $23,000 (plus catch-up), plus employer portion up to 25% of income |
| Include other (non-spouse) employees | Yes | No |
| Roth version available | No | Yes |
Plug in the appropriate numbers to the calculator in this article to figure out if you’re on track with your retirement savings plans. Will you have enough money to retire?
The bottom line
As a self-employed person, you get to control your own schedule and your own strategy. Good for you. And regardless of which plan you choose—a SEP IRA or a solo 401(k)—your retirement savings can be consistent with that philosophy.
Unlike a company 401(k), which might limit your investment choices to a few mutual funds or one fund family, these plans give you ultimate discretion over your investments and allocation. Generally speaking, that means you get access to a much wider selection of investment choices—stocks, bonds, exchange-traded funds (ETFs), and even some alternative investments are allowed.