If you decide to open an individual 401(k) with a Roth option, it’s important to know that only the employee and catch-up contributions (those limited to $19,500 per year and $6,500 per year for people 50 or older) can be Roth contributions. You’ll need an Employer Identification Number, which you can obtain from the IRS if you don’t have one already. Ben has two decades of business and finance journalism experience. Second Stimulus Check Calculator: How Much Will You Receive? Fortunately, you can use the “Deduction Worksheet for Self-employed” from IRS Publication 560 to walk you through the math. Generally speaking, you want to choose the plan that has the highest contribution limit for your situation. For instance, an entrepreneur who wants to put 10% of their net income into their SEP IRA must put 10% of worker pay into their SEP IRA, too. Assuming you’ve never had one before, a SIMPLE IRA can be set up as late as October 1 of the first year for which you wish to make contributions. “I would say that the biggest benefit of all is the Roth option,” says Desmond Henry, a certified financial planner (CFP) based in Topeka, Kan. “For someone who is a high earner, the Solo makes sense because of the Roth option.”. At Vanguard, for example, SEP IRA plans can be set up online while Solo 401(k) accounts require a phone call. If you expect to hire new employees in the near future, a SEP-IRA will cover you and your employees. Over the last several years though, price competition has brought costs down considerably at some brokerage firms. In addition, she can make an employer contribution of up to $8,000 (20% of her net earnings from self-employment). Any business with one or more employees is eligible for a SEP IRA, including freelance workers and independent contractors. That is, you are allowed an adjustment to income for any contributions you make, and distributions from the account are taxable as income. Solo 401(k) plans also allow you to make post-tax Roth contributions. Previously, a significant disadvantage to individual 401(k) plans was that they came with higher administrative costs. An employee contribution of $19,500 for 2020, An employer contribution equal to 20% of your net earnings from self-employment, and. Her net earnings from self-employment are $40,000. But for self-employed taxpayers without employees, it’s uncommon for any of the other types of plans to be a better choice. Individual 401 (k) … Employees are always 100% vested in a SEP IRA. He now writes The Red Tape Chronicles column at RedTape.Substack.com and hosts a podcast about the unintended consequences of technology. Whether you are an employee of a large company, small company, or a self-employed individual or owner of a small business, there are retirement … In some cases, the tax deduction for a SEP IRA can be nearly 10 times that of an IRA. EXAMPLE: You’re under 50 years old, and your net earnings from self-employment is $50,000. One exception is Vanguard, which charges $20 a year, but the firm waives the fee for account balances of more than $10,000. The opinions expressed are the author’s alone and have not been provided, approved, or otherwise endorsed by our. When you work for an employer, you can usually count on there being a 401(k) plan or something similar already in place that you can contribute to. An employee contribution of $13,500 for 2020 (plus an employee catch-up contribution of $3,000 for 2020 if you are age 50 or over), limited to 100% of your net earnings from self-employment, plus. Rather, it lets the self-employed and small businesses and their employees benefit from simple, tax-advantaged retirement savings accounts similar to personal individual retirement accounts (IRAs). In addition to the standard traditional IRA/Roth IRA options that everybody has, you have three more noteworthy options: Much of the IRS literature comparing these three options is rather complicated. They could, however, affect your ability to claim a deduction for a contribution to a traditional IRA, because if you have one of the business retirement plans described above, you are considered to be covered by a retirement plan at work, which means that if your adjusted gross income is over a certain amount, you will not be able to claim a deduction for a traditional IRA contribution. Since you are your own boss, youare responsible for both starting your own plan and funding it. In most cases, contributions to these plans reduce your taxable income. Note, however, that many brokerage firms do not allow for this option, so be sure to check with the brokerage firm you’re considering if it’s important to you to be able to make Roth contributions. It’s possible to find custodians who will allow non-traditional investments like real estate or even Bitcoin, but not all providers allow this. SIMPLE IRA Here's how three common retirement savings plans for self-employed workers stack up based on … Who Is Eligible For The $600 Stimulus Check? Both offer similar benefits, but their few key differences may make one better for you. Most of the retirement plan options for self-employed taxpayers function similarly to a traditional IRA. There’s one key feature of SEP IRAs that differentiate them from Solo 401(k)s: Only the employer can make contributions to a SEP IRA account. How Will Your Payment Arrive? At the end of 2019, nearly 30% of American workers were self-employed, according to Gallup. The ranks of self-employed Americans are growing. For self-employed people, however, a Solo 401(k) may offer greater annual contributions and bigger tax deductions than a SEP IRA, depending on your income. This isn't a big deal, and the paperwork at most brokerage options … For both the SIMPLE IRA and the SIMPLE 401(k), eligible employers must have no more than 100 employees who have received at least $5,000 in compensation from the employer for the … Specifically, you are allowed to make: In this case, your net earnings from self-employment is defined as your business’s profit, minus the deduction for one half of your self-employment tax. Solo 401k allows for higher annual contribution limits than a SEP IRA. And the same goes for catch-up contributions. Your particular situation will dictate which, the SEP IRA or Solo 401(k… One of the biggest benefits of being self-employed is that there are more (and better) retirement plan options available to you than are available to most taxpayers. But that’s not the only reason to pick a Solo 401(k). A SEP IRA or individual 401(k) can be set up as late as the due date (including extensions) for the business’s tax return for the year. Individual 401(k) — sometimes called a solo 401(k) or a self-employed 401(k). The SEP-IRA limit is up to 25% of an … Specifically: Also, as we’ll discuss shortly, if you have another job (i.e., a “day job”), your maximum employee contribution and catch-up contribution will be affected if you make contributions to a retirement plan at that other job. So today there are pros for using a SEP. SIMPLE IRA vs. 401(k): The Pros and Cons of Each Plan For simplicity, employers might prefer the SIMPLE IRA. A catch-up contribution of $6,500 for 2020 if you’re age 50 or older. INDIVIDUAL 401(K) Entrepreneurs who go with an SEP IRA because of potential future hires have another important consideration: All employee contributions must be the same percentage of compensation. If you do have employees and you want to set up a retirement plan for your business, I strongly recommended that you consult with a tax professional, not only because there are additional factors in the decision of which plan to open, but because there are ongoing reporting and nondiscrimination requirements as well. If you have no employees, the primary difference between the plan options is the contribution limit for each. Do You Need To Claim The Second Stimulus Check? 4 Minute Read. The Solo 401(k) annual contribution maximum in 2020 is $57,000 and $58,000 in 2021. You can unsubscribe at any time. Hiring just one employee for your business in the future—beyond your spouse—would eliminate the Solo 401(k) as an option. When Will I Get It? Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less. For a sole proprietor, this means that you can set up the plan and make contributions for a given year as late as April 15 of the following year (or October 15 of the following year if you filed for an extension). Accounting for exemptions, this works out to be about 20% of earnings for self-employed individuals, as calculated using IRS Publication 560. For flexibility, a 401(k) plan provides a wider array of choices, including a Roth … Employers do not have an annual filing requirement with a SEP-IRA as they do with other retirement plans.#3. While businesses structured as sole proprietorships, partnerships and corporations can qualify to open all three types of retirement accounts (i.e., solo 401k, SEP and SIMPLE), a solo 401k … If you ran a small business with only one other employee who was not your spouse, then, you would not be eligible to save for retirement in a Solo 401(k). Luckil… So in the battle of the SEP IRA vs 401k there are many pros and cons. Solo 401(k) accounts tend to offer a bit more flexibility in investment choices, too, Henry says. SEP IRAs and SIMPLE IRAs, however, can sometimes be good choices because of their simplicity. The only really important difference is the contribution limit. You are required to have a plan document, for instance. The term pension in this case is a bit archaic—a SEP IRA is not a defined benefit plan. All profit sharing contributions must be made to a traditional account. Articles are published Monday and Friday. The plan may also be referred to as an individual 401(k) or a one-participant 401(k). Alternatively, if you have a SIMPLE IRA, your contribution limit would be even lower ($13,500 plus 3% of net earnings from self-employment). Self-employment tax: What it is, why it exists, and how to calculate it. Assuming you do not contribute to another retirement plan for your business, your annual SEP contribution will be limited to $18,587, calculated as 20% x ($100,000 — $7,065). For example, Fidelity’s individual 401(k) has no set-up or administrative costs at all. Those that do contribute can only contribute up to $12,500 to the SIMPLE IRA, vs. 401 (k)s’ $18,000 limit. One other difference between a SEP IRA and a SIMPLE IRA is that, should you have to make an early withdrawal from a SIMPLE IRA within two years of the plan’s inception date, you will be penalized more than you would be if it were a SEP IRA (25% penalty as compared to 10% penalty). Fortunately, most of that literature is irrelevant if you have no employees. One other difference between a SEP IRA and a SIMPLE IRA is that, should you have to make an early withdrawal from a SIMPLE IRA within two years of the plan’s inception date, you will be penalized more than you would be if it were a SEP IRA (25% penalty as compared to 10% penalty). Employees are not permitted to make their own elective contributions, although a solo entrepreneur or self-employed person—who is in effect both employer and employee—may contribute acting as employer. Switching from a Solo 401(k) to an SEP IRA at some future date can be a big hassle, Henry warns. There’s obviously a lot going on here. In addition, if you have another job as an employee and you are allowed to contribute to a 401(k) at that job, contributions you make to your plan at work — to take advantage of an employer matching contribution for instance — will count against the limit for employee contributions to an individual 401(k) or SIMPLE IRA. And it works in the other direction too — employee and catch-up contributions you make to an individual 401(k) or SIMPLE IRA will count against the contribution limits for your plan at work. The contribution limits of a SIMPLE IRA vs. SEP-IRA are different too. Your net earnings from self-employment are $100,000 for 2020. Notably, since employee contributions are not allowed, SEP IRAs do not allow catch-up contributions for people 50 or older. Editorial Note: Forbes may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations. That’s because as employee they can contribute up to $19,500, but as employer they can add onto that up to 25% of their adjusted income for a maximum total contribution of $57,000 in 2020 and $58,000 in 2021. In the $100,000 example above, our hypothetical under-50 worker with $100,000 in annual net profit could make a total contribution of up to $38,087. See it on Amazon, 401k Rollover to IRA: How, Why, and Where, Single Premium Immediate Annuities and Retirement Planning, Social Security Strategies for Married Couples, the deduction for one-half of your self-employment tax, Savings Incentive Match Plan for Employees (SIMPLE IRA), and. She also has a part-time business for which she has an individual 401(k). The conclusion here? EXAMPLE: Jan is 40 years old and has a full-time job that offers a dollar-for-dollar match for contributions she makes to her 401(k), up to $4,000. Best Personal Loans For Debt Consolidation. If the same worker were 50 or older, they could add $6,500 on to that total. The reason for this is that a Solo 401k allows for both employee (salary deferral) & employer (profit sharing) contributions whereas only profit sharing contributions can be made to a Solo 401k. A Solo 401k only covers you and your spouse. Opening fees and annual fees are often zero. Given the dual advantages of Roth contribution capability and (usually) higher contribution limits, one might wonder why anybody would choose a SEP or SIMPLE IRA over an individual 401(k). As a business owner, you have several options for retirement plans. SEP IRA vs 401k: The Decision. The Forbes Advisor editorial team is independent and objective. SEP IRAs are available from most major brokerage firms and easy to set up. Must have worked for the employer (yourself) in at least 3 of the last 5 years. A solo 401 (k) covers only a self-employed individual and their spouse (if they also work in … (That is, catch-up contributions made to your plan at work will count against the catch-up contribution limit for your individual 401(k) or SIMPLE IRA.) Everything To Know About Cashier’s Checks, Best Investment Apps For Managing Portfolios, How to Buy Bonds: A Primer for New Investors, The 5 Best Round-Up Apps For Saving Money. EXAMPLE: Your business’s profit for the year is $100,000, and your deduction for one-half of your self-employment tax is $7,065. The conventional wisdom regarding the Solo 401(k) vs SEP IRA question is that self-employed people should choose the Solo 401(k) because in most cases, the potential tax savings are … Unlike a traditional 401(k) plan, SEP IRAs have little to no administrative overhead. (If you have had a SIMPLE IRA before and are setting up another one, you must set it up by January 1 of the first year for which you wish to make contributions.). A SIMPLE IRA plan is similar to a Solo 401k Plan in that it is funded by employee deferrals and additional employer contributions. He spent nearly two decades working at MSNBC.com and NBC News, and he still appears on TODAY, NBC Nightly News, and CNBC. For 2020, if you have a SEP, you are allowed to contribute the lesser of: Once the money is in the plan, you can invest it in all of the same things you would be allowed to invest in with a regular IRA (stocks, bonds, mutual funds, CDs, etc.). But it also comes with a lot of responsibilities — not the least of which is saving for your own retirement. If you have a SIMPLE IRA, you can make: For SIMPLE IRA purposes, “net earnings from self-employment” is your business’s profit, times 92.35% (to approximately account for your deduction for one-half of your self-employment tax). See it on Amazon That means a self-employed person under 50 with an annual net profit of $100,000 could contribute a total of $18,587 to an SEP IRA. Solo 401(k)s also offer catch-up contributions for people 50 and older as well as a Roth option, which lets you pay income tax now in exchange for tax-free withdrawals in retirement. Simplified is in their name for a reason: They can be easier to set up than Solo 401(k) plans, according to Henry, and they’re more widely available. Given the decline in costs, the only real remaining drawback is paperwork. These include the SEP-IRA, Solo 401(k), Cash Balance Pension Plan and even a SIMPLE IRA. The deadline for contributions is the same date. In most circumstances you can contribute more — sometimes much more — to an individual 401(k) than you could contribute to a SEP IRA or SIMPLE IRA. There are lower startup costs and operational costs for aa SEP-IRA compared to other retirement plans that would be considered “traditional.”#2. © 2021 Forbes Media LLC. SIMPLE IRAs also function much like traditional IRAs. What Happens If Your Employer Suspends Its 401(k) Program. But even in some cases where hiring employees simply isn’t in the cards, Henry sometimes advises the self-employed to choose a SEP IRA. Comparing Self-Employed Retirement Plans: Solo 401(k) vs. SEP IRA vs. (Note: These limits are not cumulative, so there’s usually no benefit to opening more than one retirement plan for your business.). Unfortunately, contributions are adjustments to income (i.e., “above the line” deductions) rather than Schedule C deductions, meaning they save you money on income tax but not self-employment tax. The employer contributions must be made as traditional, tax-deferred contributions. In most cases, an individual 401(k) plan will allow for the largest contribution. There are 4 types of retirement accounts that are specifically designed for small business owners. Unemployment‌ ‌Benefits‌ ‌Boost‌ Calculator, Simplified Employee Pension Individual Retirement Account. #1. However, unlike a Solo 401k Plan, a SIMPLE IRA plan uses an IRA-type trust to hold contributions for each employee, rather than a single plan trust that is typical of a traditional employer 401 (k) Plan. Now, since the Solo 401(k) is more popular, both plans are about equal in cost. To help support our reporting work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the Forbes Advisor site. Opening a Solo 401(k) may be somewhat trickier and more time consuming. For a sole proprietor, the deadline for SIMPLE IRA employee contributions is January 30 of the following year. SEP IRAs work in almost the exact same way as a traditional IRA. Also, the same withdrawal rules apply. That is, contributions made to the plan reduce your taxable income, and your investments are allowed to grow tax-deferred until you start making withdrawals from the plan. Here’s the tricky part: Since the Solo 401(k) owner acts as both employer and employee, both types of contributions can be made—and that means most workers can contribute more and receive a higher tax break. I’ve also made a solo 401(k) calculator that you can use. There are pros for using Solo 401(k) and there are cons for using them. When a newly minted entrepreneur or gig worker lands at Henry’s door and asks whether to open an SEP IRA or a Solo 401(k), he asks one question: “Do you have any plans to hire an employee, even in the future?” If the answer is maybe, he steers them towards an SEP IRA, which can be used to fund employee retirements. This compensation comes from two main sources. An employer contribution equal to 3% of your net earnings from self-employment. Working for yourself doesn’t mean you have to miss out on the tax benefits that regular employees get from standard workplace retirement plans, though. In addition, individual 401(k) plans allow for Roth contributions (though this is not available at all brokerage firms). This tax-advantaged retirement plan is generally limited to just self-employed individuals, though spouses who work at least part time for them may be eligible to contribute to one as well. Read customer reviews on Amazon, Corporate Finance Made Simple: Corporate Finance Explained in 100 Pages or Less Again, the primary difference is the contribution limit. The employer contribution is limited to half of the difference between your net earnings from self-employment and the employee contribution, The employee and employer contributions are limited to a combined total of (for 2020) $57,000, and. All Rights Reserved. The total contribution is limited to your net earnings from self-employment. The deadline for the employer contribution is the due date (including extensions) for the business’s tax return for the year (i.e., April 15 of the following year, or October 15 if you filed for an extension). The conventional wisdom regarding the Solo 401(k) vs SEP IRA question is that self-employed people should choose the Solo 401(k) because in most cases, the potential tax savings are higher. Solo 401(k) plans must be established by the end of the calendar year for you to benefit from the tax breaks for that tax year. A SEP IRA is simple to administer and no tax filings are required. Similarly, Vanguard’s individual 401(k) has no set-up fees and only a modest administrative fee: $20 per year for each mutual fund in the plan — and this fee is waived if you have at least $50,000 of assets with Vanguard. Funds paid into the SEP IRA are fully tax deductible up to IRS limits, giving the business or self-employed person a dollar-for-dollar reduction in taxable income. To get the best possible experience please use the latest version of Chrome, Firefox, Safari, or Microsoft Edge to view this website. sep-ira Works well for business owners who prefer to provide a retirement benefit to all employees (including themselves) by making employer contributions. Self-employment has many perks. The Most Significant Distinctions Between the SEP IRA vs Solo 401k The term IRA stands for “Individual Retirement Account,” one of the two most standard retirement accounts that any … So if you’re looking to have a small team, … The maximum SEP IRA contribution is the lesser of 25% of adjusted net earnings or $57,000 for 2020 ($58,000 for 2021). An employer can contribute a 25% maximum of an employee’s pay to a SEP-IRA.#4. (The following is an excerpt from my book Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.). While SEP IRAs usually have a broader range of choices than 401(k) accounts, the choices are more limited than those available in a standard brokerage account. Click here to read more, or enter your email address in the blue form to the left to receive free updates. A Solo 401(k) is essentially a 401(k) plan designed for individuals. However, when you work for yourself, it's a different story. The Solo 401 (k), on the other hand, is great for anyone who is fully self-employed in a one-person business. Congress created the Simplified Employee Pension Individual Retirement Account (SEP IRA) in 1978 to extend the IRA concept to small businesses. Finally, the SIMPLE IRA is best if you’ve started adding employees are no longer eligible for a Solo 401 (k) … With a few exceptions, you cannot make withdrawals from the plan prior to age 59.5 without being penalized. When opening an account, be sure to note minimum investment requirements and investment options. 401(k) 403(b) Solo 401(k) SIMPLE IRA: SEP IRA: Who it’s for: Any type of public or private company: Employees of public schools and tax-exempt organizations: Solo entrepreneurs: Employers with 100 or fewer employees and self-employed individuals: Self-employed individuals and small business owners: Who may contribute: Employer and employee: Employer and … The maximum employee contribution she can make to her individual 401(k) for the year is $15,500 ($19,500 — $4,000). In addition to usually allowing for greater contributions, individual 401(k) plans have another benefit: If you would prefer to do so, you can make Roth contributions to an individual 401(k) rather than pre-tax (“traditional”) contributions. For side-hustle workers who don’t pay withholding taxes and worry about their end-of-year tax bill, the deduction can really help. “In fact, most taxpayers can simply open a SEP account online with their brokerage firm and manage it themselves.”. (For more information, see the book on Amazon: Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.). But if you’re self-employed with no employees, the choice depends on how much you plan to save. SEP IRA Solo 401K SIMPLE IRA; Eligibility Requirements: Age 21 or older. This includes self-employed people, sole proprietorships, LLPs, C corporations and S corporations. The Individual 401k and the SEP IRA have comparable maximum limits, but due to the way the contribution is calculated a self employed individual may be able to contribute more into an Individual 401k versus a SEP IRA at the same income level, therefore maximizing retirement … Forbes adheres to strict editorial integrity standards. What Exactly Can Be Taken From You In A Lawsuit? Unlike a SEP-IRA, a Solo 401(k) can offer a Roth option for the employee contributions. Bob Sullivan is a Peabody-award winning journalist and the author of five books, including New York Times Best-Sellers, Gotcha Capitalism and Stop Getting Ripped Off! A SEP IRA plan is considered a good option for small business owners with less than 5 employees. “If you want to invest in the alternative space, you can do that in a Solo 401(k)…like cryptocurrencies, life insurance, metals,” he says. If you’re deciding between a solo 401(k) and a SEP IRA, and you have employees, the choice is easy: SEP IRA. An individual 401(k) plan functions very much like a 401(k) plan with a person’s employer. Employer contribution of $20,000 (20% of $100,000). Must have received at least $600 … The Takeaway: Solo 401(k) vs. SEP IRA. Companies with only a single employee can take advantage of SEP IRAs, meaning they can be a good choice for solo entrepreneurs or gig workers. When comparing a SEP IRA to Solo 401(k), it’s important to know that business owners can make larger retirement contributions to a Solo 401(k) … You can contribute more to a Solo 401k vs. SEP IRA . Eligibility requirements are fairly straightforward: Anyone who generates net profits from a sole proprietorship, LLC or other business organization can open a solo 401(k) as long as they have no employees aside from their spouse. One thing to note is that if you also have access to a 401 (k) through another job, you … You can’t open a solo 401(k) plan if you have an employee other than your spouse. To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. Solo 401(k)s also offer features more on par with other employer-sponsored retirement plans that SEP IRAs lack: You can, for example, generally take out a loan from your Solo 401(k) equal to the lesser of $50,000 or 50% of your account balance. Can contribute a 25 % maximum of an employee other than your.... Boss, youare responsible for both starting your own boss, youare responsible for both starting your own boss youare. The difference is the contribution limit is $ 50,000 calculate it plan is. Themselves, in addition to the IRAs which are made available to their.... Self-Employed with no employees, the choice depends on how much will you?... Maximum match from her employer, she can make an employer contribution equal to 3 % of an … Investing. Is fully self-employed in a Solo 401 ( k ) will likely require you to out... 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Or older, they could add $ 6,500 for 2020 if you have a plan document, instance! In a Lawsuit take care of that 600 Stimulus Check going on here fill out more forms than opening Solo... Even a SIMPLE IRA employee sep ira vs simple ira vs solo 401k consequences of technology better for you form 5305-SEP, but the brokerage usually! Date can be opened online personal IRAs catch-up contribution of $ 100,000 for 2020 annual... In costs, the deduction can really help and Solo 401 ( k ) the deadline for SIMPLE contribution... Suspends Its 401 ( k ) plan will allow for the largest contribution real remaining drawback is paperwork person. Benefits, but their few key differences may make one better for you an SEP IRA vs 401k there cons. Trickier and more time consuming eliminate the Solo 401 ( k ) and there are 4 types plans. Make a contribution in the battle of the SEP IRA vs 401k: the Decision your in. Sep-Ira as they do with other retirement plans. # 3 eliminate the Solo 401 ( k ).. Similar to a Solo 401 ( k ) has no set-up or administrative costs is required, as. An account, be sure to note minimum investment requirements and investment options self-employed no! To no administrative overhead really important difference is the contribution limit is $ 57,000 and $ 58,000 in.! Lot of responsibilities — not the least of which is saving for your situation of retirement plans what. Left to receive free updates reason to pick a Solo 401 ( k ), on the other of... And there are cons for using them if you ’ re under 50 years old, and Taxes... Net earnings from self-employment ) are made available to their employees, Fidelity s! Only really important difference is the 4 % Rule for retirement withdrawals brokerage will usually take care that!

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