Solo 401(k) Versus SEP IRA: Saving for Retirement While Self Employed

Rachel Curry - Author
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Jan. 26 2022, Published 3:45 p.m. ET

If you’re self-employed, you don’t get the perk of a 401(k) match to help pad your retirement savings. Still, many entrepreneurs prefer the agency of being an independent contractor. When saving for retirement, there are two types of accounts that self-employed individuals usually go for—Solo 401(k) and SEP IRA.

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What’s the difference between a Solo 401(k) and a SEP IRA? Is one better than the other when saving for retirement?

What's a Solo 401(k)?

A one-participant 401(k), or Solo 401(k), is a type of 401(k) savings plan suited for a single-member business owner with no employees. It might cover the individual’s spouse if necessary.

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Solo 401(k) plans are different from other 401(k) plans because the owner is both the employee and employer. To find out how much you as a self-employed person can contribute to a Solo 401(k) annually, you’ll need to make some calculations.

A Solo 401(k) owner under 50 years old can contribute elective deferrals up to 100 percent of earned income or up to $20,500 in 2022. (For the 2021 tax year, the contribution limit is $19,500.) Anyone aged 50 and over with a Solo 401(k) can contribute elective deferrals up to $27,000 in 2022 (or $26,000 for the 2021 tax year). This includes catch-up contributions for people nearing retirement age.

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Owners can also contribute employer non-elective contributions for a maximum of 25 percent of compensation. With these two methods, an individual can contribute no more than $61,000 in total contributions to a Solo 401(k) in 2022 ($58,000 in 2021).

What's a SEP IRA?

A Simplified Employee Pension IRA, or SEP IRA, is a different take on a traditional IRA. Small business owners can make contributions to SEP IRAs on behalf of their employees, but usually self-employed individuals contribute for themselves as their own boss.

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For 2022, contribution limits for SEP IRAs are up to 25 percent of compensation (up to $305,000) or $61,000, whichever is less. This is up from $58,000 in 2021.

Is a Solo 401(k) or SEP IRA better? It depends.

For both options, the Solo 401(k) and SEP IRA, contributions can grow tax-deferred until you're ready to withdraw at retirement age. They also both have the perk of offering tax-deductible contributions for business owners.

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If you’re a small business owner with a few employees, you can’t get a Solo 401(k), but you can still get a SEP IRA.

If you’re self-employed for part of your work but operate as a W-2 employee for part of the time, a Solo 401(k) might be better. Also, Solo 401(k)s offer the benefits of catch-up contributions for people ages 50 and older. Plus, you might be able to do a Roth-style Solo 401(k) without changing your plan. This means you can pay taxes on contributions now while you’re in a lower tax bracket, assuming you’ll be making more money when you reach retirement age.

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