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SEP IRA: What You Need to Know

Weird but true: Among my money nerd friends, maxing out our yearly retirement contributions is like a competitive sport. And when it comes to retirement options for freelancers, if you’re comparing the Solo 401(k) to the SEP IRA, the SEP IRA is typically seen as the lesser of the two.

Why’s that? Well, for one, the contribution limits for a SEP IRA are lower than that of a Solo 401(k). And those dead set on maximizing their retirements are all about finding ways to set aside money for retirement. After all, the greater your retirement contributions, the lower your taxable income. In other words, it’ll knock down how much you’ll owe in taxes.

That being said, as freelancers being aggressive with our retirement savings isn’t always feasible. Which is why it’s important to consider your options including contributing to a SEP IRA:

SEP IRA versus Solo 401(k)

Let’s start by looking at the two major types of retirement accounts for self-employed folks: SEP IRAs and Solo 401(k)s.

I have both a SEP IRA and Solo 401(k), and the SEP IRA was a lot easier to set up. For instance, when I set up a Solo 401(k), it was a long process with a lot of paperwork. An SEP IRA usually doesn’t require much paperwork, and it’s a relatively quick and painless process.

If you have a Solo 401(k), you can make both contributions as an employer and employee. However, with a SEP IRA, you can only make employee contributions. That being said, if you’re self-employed, you probably don’t have any employees other than yourself.

Let’s Break it Down

If you do have employees other than yourself, you’ll need to make the same percentage of contributions relative to the salary of each of your employees.

For example, if one of your employees receives a $40,000 salary and another is paid $60,000, and you decide to contribute 10% of their net compensation, then employee A will receive $4,000 annual contribution, and employee B gets $6,000.

When it comes to SEP IRAs, if you’re considered self-employed, you can contribute up to 20% of your net income — give or take. Note you’ll need to use a special calculation to figure out how much you can contribute each year. It involves deducting some of your self-employed taxes. The IRS has more deets on this computation, or you can talk to an accountant to figure out exactly how much you can put into your SEP IRA.

So how much can you contribute for a Solo 401(k)? For 2020, on the employee side, you can contribute $19,500 or $26,000 if you’re 50 and over. Plus, as an employer you can contribute up to 25% of your net income. If you’re self-employed, like the SEP IRA, you’ll have to use a special formula to gauge how much you can put into your Solo 401(k) plan.

Here’s the kicker: If you have more than one employee, you can’t open and contribute to a Solo 401(k). Solo 401(k)s are designed for self-employed folks where the only employee is you and your spouse.

SEP IRAs versus IRAs

Anticipate having less than $6,000 to squirrel away for retirement? Then you might not have to worry about opening a tax-advantaged retirement account specific to being self-employed.

IRAs are available to anyone —you don’t have to be self-employed to open an account. What’s more, it’s not as if you have to choose between contributing to a SEP IRA or to a regular IRA. You can make contributions to both.


How do you go about choosing between contributing to a SEP IRA or a Solo 401(k)? There’s certainly no one-size-fits-all.

To make that decision you have to take a handful of factors into account. Namely, your yearly projected income, how much you’re able to save for retirement, and if you have any employees.

Let’s Look At a Few Scenarios

If you’re a sole proprietor or a freelancer, you might not have to set up a small business specific retirement plan such as a SEP IRA or Solo 401(k) at all.

Let’s say your tax filing status is single and your income is projected to be less than $65,000 in 2020. That makes you eligible to make a deductible Traditional IRA contribution up to $6,000. And if you decide a Roth IRA is best for you, and your income is less than $124,000 in 2020, you’re eligible to contribute up to $6,000 to your Roth IRA.

The SEP IRA and Solo 401(k) options typically come into play if you’re over the aforementioned income limits and are able to contribute more than $6,000 to retirement accounts in 2020. This is also where the number of employees you have comes into play. “Since Solo 401(k) ’s are specifically designed for sole proprietors with no employees, it’s typically the best option for that scenario,” says Tyler Dolan, a certified financial planner and vice president of Keenan Financial.

As we talked about, in a Solo 401(k), you’re able to contribute $19,500 for yourself as a sole proprietor. And as the “employer” you can contribute up to 25% of your compensation.

However, if you have a small number of employees, a SEP IRA can be a good fit. “You’re eligible to contribute up to 25% of your compensation to your SEP IRA, but the catch is you’re required to contribute to each of your employee’s SEP IRAs as well,” says Dolan.

Bottom Line

It’s complicated. If you have questions, it’s best to talk to a financial planner to figure out the best route for you.

Because I care about maximizing contributions and I only have myself as an employee, I have both a SEP IRA and solo 401(k) set up. Even so, situations can always change. Ultimately, it’s best to stay on top of your retirement goals and make tweaks along the way.

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