Solo 401(k), SEP and SIMPLE IRA offer great self-employed retirement options
Solo 401(k), SEP and SIMPLE IRA are three great options for self-employed business owners and their employees. Even if you’re a sole-proprietor or independent contractor, one of these plans can help you plan for retirement and enjoy real tax benefits.
Solo 401(k), SEP and SIMPLE IRA: How Are They Different?
The main differences among Solo 401(k), SEP and SIMPLE IRA plans are contribution limits and requirements.
Solo 401(k)
Solo 401(k) plans are also known as individual 401(k) or i401(k) plans. These are the best option for sole proprietors without any employees. They operate similarly to regular 401(k) plans. You can invest either pre-tax dollars (like a traditional IRA) or after-tax dollars (like a Roth IRA). With a pre-tax plan, the money you invest is not taxed as income until you make withdrawals. With an after-tax plan, you invest money that you’ve already paid taxes on, so you don’t have to pay tax when you take money out (including the money your investment has earned).
The contribution limit is up to 100 percent of your income. In 2024, there’s a cap on employee contributions of $23,000 ($30,500 if you’re over 50). But you can contribute even more, as your own employer. That limit is 25 percent of your total income, but with a higher cap amount. In all, with both employer and employee contributions, you can invest up to $69,000. And your spouse can invest the same amounts.
Cons? Because of the dual contributions, solo 401(k) plans can take a little extra figuring out. Also, once the total in your account is over $250,000, you have to file a Form 5500-EZ with the IRS.
SEP IRA
A SEP IRA operates similarly to a pre-tax solo 401(k) plan, but there are two major differences – employees are eligible to participate, but only employers get to contribute. The contribution limit is the same as the solo 401(k) – 25 percent of compensation up to $69,000. However, you don’t get to make larger “catch-up” contributions as you get older. Be aware, too, that the same employer contribution must go to every plan member. You can’t give yourself a big contribution as the boss, and a little one to your employees. These plans are relatively easy to set up and administer.
SIMPLE IRA
SIMPLE IRAs are for small businesses with up to 100 employees. Both employer and employee can contribute. In 2024, employees can contribute up to $16,000 (or $19,500 if age 50 or older). Employer contributions are required for any employee participating in the plan. Employers make matching contributions up to 3 percent of the employee’s pay, not limited by any annual compensation limit. Or they can make non-elective contributions equal to 2 percent of the employee’s compensation based on a maximum salary of $345,000 in 2024. There is no “Roth version” of a SIMPLE IRA – employees don’t pay tax on contributions until they take money out.
Consult with your friendly accountant or investment counselor to help you choose among Solo 401(k), SEP and SIMPLE IRA options.
Links
Nerdwallet has a handy retirement calculator to help you figure out how much you’ll save by retirement age.
Can you contribute to two retirement plans if you work two jobs?
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