What is the best retirement plan for the self-employed?

For those who are self-employed, it is essential that you fund a pension plan yourself. Two of the best options are a SEP-IRA and a solo 401(k). As we reach the midpoint in 2022, it’s important to have a retirement plan option in place for yourself. Let’s take a look at the features and benefits of each plan.

Single 401(k)

A solo 401(k) is a retirement plan that is available to business owners, a spouse who is involved in the business as well as any partner in the business. Non-owner employees are not eligible to participate in the plan. Solo 401(k) plans are also known as individual 401(k)s and 401(k) for the self-employed.

Employee contributions are the same as with an employer-sponsored 401(k), $20,500 plus a $6,500 catch-up contribution for those age 50 or older for 2022. employer can make profit-sharing contributions of the lesser of 25% of employee compensation up to a maximum combined contribution of $61,000 or $67,500 for those age 50 or older.

Solo 401(k)s can be offered as both a traditional 401(k) and a Roth 401(k). Diet loans may also be offered. A ​solo 401(k) must be in place by the last day of the year for contributions to be considered for the year, for 2022 this would be December. 31, 2022.

Most major brokers and custodians offer the option of opening a solo 401(k) account. Money in the account can be invested in virtually any type of investment vehicle offered by the custodian. These can be individual stocks and bonds, ETFs and mutual funds.

Some benefits of a ​solo 401(k):

  • As long as you have earned income, you can fund the plan. You can generally contribute up to 100% of your earned income to 401(k) up to annual contribution limits. This can allow for larger contributions in years when your income is lower than a SEP-IRA.

  • The availability of a Roth option for the contributory 401(k) portion of the plan provides additional flexibility for those wishing to make larger Roth contributions.

Disadvantages of a solo 401(k):

  • The plan must be established by December. 31 of the calendar year for which you wish to contribute. Contributions may be made afterwards, check with your tax professional to determine the due dates for employee and employer contributions.

  • A solo 401(k) is not an appropriate small business retirement plan for a business with non-owner employees.

SEP IRA

SEP is short for Simplified Employee Retirement. A SEP-IRA is a retirement plan that allows business owners and employees to participate. Contributions are paid by the employer, no individual contributions are allowed. SARSEPs are a version of a SEP-IRA that allows employers to make contributions in the form of an employee’s salary deferral. SARSEPs have not been allowed to be established since 1996 due to a change in the rules governing them. SARSEPs established before this date are grandfathered and contributions can continue.

A SEP-IRA can be opened on the company’s tax filing date, including extensions. Contributions for the previous calendar year can also be paid on this date. The maximum contribution for 2022 is 25% of the employee’s remuneration up to a maximum of $61,000. The percentage limit may be lower for those who are sole proprietors and file a Schedule C as part of their tax return. This should be discussed with your tax professional.

Unlike a solo 401(k), a SEP-IRA does not allow a Roth option and no loans can be made against your plan balance.

Benefits of a SEP-IRA:

  • The plan can be established and the contributions paid for the tax year up to the date of declaration of the business tax, including extensions.

  • Employees can participate in the plan.

Disadvantages of a SEP-IRA:

  • If your income is low in a given year, this will limit your ability to contribute.

  • There is no Roth option available for a SEP-IRA.

  • If employees participate in the plan, they must receive the same percentage of their compensation as a contribution as the business owner. It can get expensive.

Invest in alternative assets

Generally, most custodians will not allow many alternative assets to be held in either type of plan. These could include:

  • Investment property

  • Goods

  • Cryptocurrencies

  • Cattle

  • Tax lien certificates

These types of alternative investments and a host of others can generally only be held in a Solo 401(k) or self-directed SEP-IRA. There are a number of self-directed retirement account platforms that offer the ability to open retirement accounts and hold alternatives in your retirement accounts.

A brief comparison

This table provides a brief comparison of some of the key features of the ​solo 401(k) versus the SEP-IRA.

Single 401(k)

SEP IRA

Employee contributions allowed

Yes

Nope

Authorized loans

Yes, if the plan allows it

Nope

Roth option allowed

Yes

Nope

Maximum total contributions for 2022

$61,000 or $67,500 for savers over 50

$61,000 regardless of age

Deadline to start the plan for the current tax year

December 31st

Date of tax declaration, including extensions

​If you are self-employed, it is important to set up a retirement plan for your business to allow you to accumulate a retirement nest egg. Solo 401(k) and SEP-IRA are good options. It may be beneficial to consult with a financial or tax advisor to determine the type of self-employed retirement option that best suits your situation.


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