Retirement Saving for Self Employed: SEP and Solo 401(k) Options

Summary: Discover retirement saving options for self-employed individuals. Learn about SEP and Solo 401(k) plans, their benefits, and contribution limits.

Retirement Saving for Self Employed

Self-employment can be risky, but it can be made less so with good retirement-saving options. I want to give some love to two under-appreciated retirement plans: (1) the Simplified Employee Pension (SEP) and (2) the Solo 401(k)—available to anyone who generates income from self-employment.

Simplified Employee Pension (SEP)

SEPs are supercharged IRAs, following the same rules but allowing for higher contributions. In 2023, the self-employed can contribute the lesser of (a) $66,000 or (b) 20% of their net adjusted income (gross income from self-employment minus expenses and half of one’s self-employment tax).

How to Set Up and Administer

SEPs are easy to set up and administer. You can download Form 5305-SEP from the IRS’s website, or you can get the form from your financial advisor. You do not even have to send the form back to the IRS—simply file it in your records. Most mutual fund companies, brokerage houses, and insurance companies offer prototype SEPs. You can invest your SEP in stocks, bonds, funds, CDs, etc.

You can also make contributions to your SEP until you file your taxes, including extensions. Therefore, someone eligible for an extension can open a SEP for 2019 upon filing tax returns in October 2023.

SEPs are also flexible. You can change the amount you invest in your SEP from year to year, and some years you can decide not to fund it at all. Contributions are 100% tax deductible; they grow tax-deferred. However, they are taken above the line and cannot be Schedule C deductions, which means you save on income taxes but not self-employment taxes.

Solo 401(k)

Self-employed individuals who want to save more than 20% on taxes should look into the Solo 401(k), which allows them to put in the 20% plus an additional $22,500 of employee contributions. Moreover, people aged 50 and over can add another $7,500. A spouse who draws a salary can also contribute.

Higher contribution limits

People aged 50 and over with a net adjusted income of $100,000 can contribute $20,000 to a SEP. However, if they open a Solo 401(k), they could contribute the $20,000, plus the $22,500 of employee contribution, plus another $7,500 in age 50 catch-up, for a total of $50,000.

There is a limit, however. In 2023, that number is $57,000. However, catch-ups do not apply, so people aged 50 and over with enough income can contribute $63,500. One thing to keep in mind: the $57,000 is per employer, while the employee limit is per person.

If you have more than one job from which you contribute to a retirement plan, the most you can do in total is $19,500, and if you’re 50 or over, the $6,500 catch-up. You can add a Roth component to a Solo 401(k) so that some or all of the employee portion of your contribution ($18,000) can go into a Roth account.

A Solo 401(k) does require a little more paperwork than a SEP, and once the assets in the plan reach $250,000, you will have to file Form 5500 EZ with the government every year. However, Form 5500 EZ is only a two-page form.

The deadline for establishing a Solo 401(k) is December 31 of the year in which you would like to receive the tax deduction. However, you can fund the employer portion  (20% or less) until you file your taxes, including any extensions.

With the Solo 401k, you can also access money tax-free using a Solo 401(k) loan. You can borrow 50% of the total 401(k) value, up to a maximum of $50,000. IRS rules do not allow loans with a SEP IRA.

These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted on as individualized investment advice.

With So Many Investment Possibilities, How Do You Know What’s Best?

Tim is an independent financial advisor with the experience and knowledge you can trust to know which investment vehicles may be right for you. Whether you’re an individual, small business, or company executive, he’ll set you up with a portfolio attuned to your unique needs.

Why I Remain Duel Registered

I remain registered as an investment adviser representative and as a registered representative. Most of my business is as a fee-only investment advisor representative, where I charge a client a fee or an hourly rate for my advice. I like this arrangement because it is not product-based, and I can get paid to provide ongoing advice to my clients.

However, I keep my registered representative license because when I compare a commission product, it makes more sense for the client. For example, a new client who is 25 years old wants to purchase a Roth IRA with $6,000—I cannot imagine charging them a fee for the next forty years.

Also, I like to use American Funds for some clients with big 401k or 403b accounts, if I recommend that they roll over their money. If their 401k account balance is over a million, they pay no sales charge. And American Funds has some of the lowest management fees for actively managed funds. They also offer excellent funds for customers interested in generating retirement income. But I need to have a registered representative licensed to provide this option.

What to Do Now

If you have an IRA and work with a financial advisor, now is an excellent time to review the financial planning arrangement, fee or commission, best interest, or fiduciary. Also, if you are thinking of rolling over a 401(k) or 403(b), ensure your decision is consistent with the new rule.

Suppose you happen to administer a retirement plan for an employer: Ensure that any advisor compensation is aligned with the new interpretation from the DOL and the new rule from the SEC.

These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only and should not be construed or acted upon as individualized investment advice. Content provided via links to third-party sites should not be considered an endorsement of content that we cannot verify completeness or accuracy of.

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Tim Hayes

Tim has offices located in Boston and South Dartmouth, Massachusetts. He is licensed to handle securities in six states, including Massachusetts, Rhode Island, New Hampshire, Connecticut, Maine, and Florida. Moreover, he can provide investment advisory and financial planning services to clients in all 50 states.
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