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Luckily, there are products on the market that can help you out. Here are two retirement plan options worth considering if you're self-employed or a business owner.

What is SEP IRA?

simplified employee plan (SEP) IRA is a type of IRA that works well for the self-employed or the small business owner. If you have employees, they can make contributions. But this can be an expensive proposition since contributions for employees must match the percentage of the salary that the owner makes for themselves. So if you've got employees, another plan such as a 401(k) or a Simple IRA might be a better choice. (If you're interested in setting up a 401(k) plan for your employees, check out services such as America's Best 401k, which can help you provide your employees with quality, low-cost plan.)

Some features of the SEP IRA include:

  • Contributions are made entirely by the business. There are no employee contributions.
  • Contributions are a business expense.
  • Contributions can be made up to 25% of compensation. For those who are sole proprietors, this might actually end up as 20% of self-employment income due to the way the calculation flows through Schedule C.
  • The maximum contribution for calendar year 2020 is $57,000.
  • SEP IRA accounts are available through most major custodians.
  • Investment choices are generally the same as for a regular IRA account.
  • A SEP IRA account can be opened and funded up until the date your tax return is filed, including extensions for the prior year.

However, you might want to take note of these limitations:

  • There are no loans available from a SEP IRA.
  • There is no Roth option available.

What is solo 401(k)?

solo 401(k), also called an “individual 401(k),” is a great solution for the self-employed as well. The solo 401(k) offers both employee and employer contributions. Most major custodians offer a solo 401(k). However, the rules may differ a bit from custodian to custodian.

Some features of the solo 401(k):

  • The plan is available only to business owners, spouses involved in the business, and partners. Other employees are not allowed to participate.
  • Employee salary deferrals are allowed, as well as employer profit-sharing contributions.
  • The limits for employee deferrals are the same as for a 401(k) plan offered by an employer. The limit is $19,500 annually with a $6,500 catchup for those who are 50 or over at any point during the year.
  • The maximum combined employee contributions plus employer profit-sharing contributions cannot exceed $57,000 for 2020, with an extra $6,500 up to $63,500 for those who are 50 or over during the year.
  • Most major custodians support solo 401(k)s. Investment options are generally the same as available to other investors in brokerage or IRA accounts. However, some custodians may have restrictions. So it is the best check before opening your account.
  • In order to take a deduction for the current tax year, the account must be opened by Dec. 31 of that year.
  • Both salary deferral and employer profit sharing contributions can generally be made until the date your return is filed, including extensions. This can vary for the salary deferral based on your business’s structure. It's best to check with a knowledgeable tax professional here.
  • Loans and a Roth option are permitted. But you should check the rules for the plan offered by your custodian to confirm this.
  • There are minimal governmental filing requirements that generally don’t kick in until the plan balance exceeds $285,000.

So which plan is best for you?

While there are some similarities, there are some differences too. And as with most things in the world of investing, there's not a one-size-fits-all solution.

The SEP IRA will be the easiest to open. A plan can be started up to the date that your return for the prior year is filed, including extensions. However, while the solo 401(k) might involve a bit more paperwork to open, the difference here is small.

There's a bigger difference that's worth taking into consideration.

In years when your income may be lower than usual, the “percentage of compensation” method used for calculating SEP IRA contributions will result in a lower contribution amount for you even if you have the cash to make a larger contribution. In addition, the SEP IRA doesn't allow for catch-up contributions.

With a solo 401(k), as long as your compensation exceeds the $19,500/$26,000 annual limits, you can contribute the full amount. So if you're really looking to save for your retirement big-time, a solo 401(k) might be your best bet.

Conclusion

When you're self-employed, it can be easy to overlook investing in a retirement plan. (After all, you don't have an HR department sending you reminder emails about signing up for an employer-sponsored program.) But there's no reason why you can't be saving too. No matter which plans you choose — whether it's a solo 401(k) or SEP IRA or another kind of retirement savings program — make sure to do your due diligence. Talk with a trusted financial expert (wealth management firm choosing a custodian.

About the Author

Roger Wohlner

Roger Wohlner

Freelance Contributor

Roger Wohlner is an experienced financial advisor, finance blogger and freelance writer based in Arlington Heights, Ill. His expertise includes providing financial planning and investment advice to individual clients, 401(k) plan sponsors, foundations and endowments.

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