Self employed individuals who would like to make a retirement contribution in excess of the limits of the Traditional or Roth IRA usually select either the Solo 401k, SEP IRA, Defined Benefit Plan or Simple IRA.
These self employed retirement plans are popular because they offer higher contribution limits and some plans permit loans.
A Keogh Plan is another self employed retirement plan option. Prior to the 2001 EGTRRA law, defined contribution Keogh plans were a popular choice for self employed business owners. This law change made a Solo 401k or SEP IRA advantageous compared to a Keogh plan for many self employed individuals.
SEP IRA
Features:
- 2023 SEP IRA contribution limit maximum is $66,000.
- Easy to set up and minimal administrative responsibilities.
Disadvantages:
- A Solo 401k may provide a larger contribution compared to a SEP IRA at the same income level.
- For those age 50+ there isn’t an additional catch-up provision like there is with the Solo 401k.
- Loans are not permitted
What are the advantages of a SEP IRA?
The SEP IRA has broad appeal due to its high maximum contribution limits and its ease to set up and maintain. The 2023 SEP IRA contribution limit maximum is $66,000. The annual contribution into a SEP IRA is based on a percentage of W-2 wages if you are incorporated or net income if you are a sole proprietorship. The SEP IRA is a great choice for self employed business owners who would like to contribute up to 25% of their W-2 wages or 20% of net self employment income.
S or C corporation or a LLC taxed as a corporation
For incorporated businesses up to 25% of W-2 wages can be contributed into a SEP IRA.
Sole proprietorship, partnership or a LLC taxed as a sole proprietorship
Annual contributions up to 20% of your net adjusted self employment income (or net adjusted business profits) can be contributed into a SEP IRA.
Learn more about a SEP IRA.
Solo 401k
Features:
- 2023 Solo 401k contribution limit is $66,000 ($73,500 if age 50 or older due to a “catch-up” provision).
- Tax free loans are permitted with a Solo 401k plan. Loans are permitted up to 50% of the total value of the Solo 401k up to a maximum of $50,000.
- Roth 401k – There is an option to make Roth 401k contributions with the salary deferral portion of the Solo 401k. Contributions into a Solo Roth 401k are not tax deductible, but withdrawals are tax free after age 59 ½.
Disadvantages:
- Potentially greater administrative responsibilities and administrative fees compared to a SEP IRA.
What are the advantages of the Solo 401k?
The term Solo 401k is commonly used to refer to the “Individual 401k” (also known as a Self Employed 401k, Personal 401k, Uni-k and Single k). The SEP IRA and Solo 401k are popular because both plans have high contribution limits and have completely discretionary annual funding requirements. In 2023 a SEP IRA has a maximum contribution limit of $66,000 and a Solo 401k has a contribution limit of $66,000 ($73,500 if age 50 or older).
A SEP IRA is easier to setup and has less administrative costs than a Solo 401k, however a Solo 401k may allow a greater contribution at the same income level due to the way the contribution is calculated.
After tax Roth contributions can be made into a Solo 401k. Roth 401k contributions are not tax deductible, but are received tax free when withdrawn after age 59 ½. SEP IRA contributions can only be made pre-tax and does not have a Roth option.
Another important distinction between these self employed retirement plans is a Solo 401k has a loan provision. IRS rules do not allow loans with a SEP IRA. Solo 401k loans are permitted up to 50% of the total 401k value with a $50,000 maximum.
Learn more about the Solo 401k.
Defined Benefit Plans
Features:
- Depending on the age and income of the business owner, annual contributions can be $100,000 to $250,000 or more.
- Loans may be permitted, however this may increase annual funding requirements.
Disadvantages:
- More expensive to set up and to maintain.
- Rigid annual funding requirements.
What are the advantages of a Defined Benefit Plan?
Do you want to contribute more than the contribution limits allowed by the SEP IRA or Solo 401k? Then consider a Defined Benefit Plan. The Defined Benefit Plan is appropriate for high income earners who want to make tax deductible contributions in excess of the maximum limits of the Solo 401k or SEP IRA. Defined Benefit Plans offer substantial tax deductible retirement contributions and significant future retirement income. Depending on your age and income the annual contribution to a Defined Benefit Plan can exceed $100,000.
Defined Benefit Plans have greater administrative fees and more rigid annual funding requirements, but may be ideal for business owners who wish to shelter the largest percentage of their income and/or who want to make the largest retirement plan contribution permitted by IRS rules.
Learn more about the Defined Benefit Plan.
Simple IRA
Features:
- A Simple IRA is easy to set up and has low administrative responsibilities.
- 2023 Simple IRA contribution limit is $15,500 or $19,000 if age 50 or older. In addition, there is a maximum 3% employer contribution.
Disadvantages:
- Relatively low maximum annual contribution limits.
- Loans are not permitted
- What are the advantages of a Simple IRA?
Self employed business owners that have a Simple IRA are able to contribute up to 100% of their income up to the maximum contribution limits of $13,500 or $16,500 if age 50 or older. As a result, significant contributions can be made into a Simple IRA even at lower income levels. A good candidate for this plan doesn’t mind the relatively low maximum contribution limits. Self employed individuals who would like to contribute in excess of the limits of a Simple IRA should consider a Solo 401k since it has higher contribution limits.
What are the advantages of a Simple IRA?
Self employed business owners that have a Simple IRA are able to contribute up to 100% of their income up to the maximum contribution limits of $15,500 or $19,000 if age 50 or older. As a result, significant contributions can be made into a Simple IRA even at lower income levels. A good candidate for this plan doesn’t mind the relatively low maximum contribution limits. Self employed individuals who would like to contribute in excess of the limits of a Simple IRA should consider a Solo 401k since it has higher contribution limits.
Learn more about the Simple IRA.