Is your retirement plan open for business?
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So youâve decided to ditch the corporate job and join the ranks of the self-employed. Itâs a bold step. Taking charge of your own career means setting your own hours, implementing your own strategy, and being your own boss. But it doesnât mean having to sacrifice your retirement savings plan.
As an independent contractor, freelancer, gig worker, or small business owner, you can choose between two specialized retirement plans: a solo 401(k) or simplified employee pension plan individual retirement account (SEP IRA). Choosing the right self-employed retirement plan depends on your income, goals, and how you structure your business.
Key Points
- A SEP IRA works like a traditional IRA, customized for freelancers and other self-employed individuals.
- A solo 401(k) functions like a traditional 401(k), but itâs designed for business owners (and their spouses) with no employees.
- Both options let you contribute up to the same limit, but the contribution rules differ.
How a SEP IRA works for self-employed retirement savings
A SEP IRA works like a traditional IRA. Contributed funds are tax deductible and grow tax deferred until retirement. The plan is particularly useful for gig workers who have a traditional 401(k) through a primary job, but want to save additional income earned from side work for retirement.
Pros and cons of a SEP IRA for self-employed individuals| Pros | Cons |
|---|
| Allows contributions of up to 25% of net income (after deducting half of your self-employment tax and contributions to the SEP), up to $69,000 in 2024 and $70,000 in 2025 | Doesnât permit catch-up contributions |
| Simple to set up and maintain | No Roth option offered; catch-up contributions not permitted |
| Permits contributions to employeesâ retirement if the business grows | Requires employers to contribute equally to all employees, including themselves |
SEP IRA plans are subject to the same rules as traditional IRA plans when it comes to withdrawals. SEP IRA holders pay taxes on withdrawals and incur a 10% penalty for early withdrawals. There are also required minimum distributions that start at age 73.
Why a solo 401(k) could be your best retirement plan
Tax rules changes to watch out for
A solo 401(k) is similar to a traditional 401(k), offering tax breaks, tax-deferred growth, and the option to open a Roth account. But itâs specifically designed for business owners with no employees, although the ownerâs spouse can also participate if they earn income from the business.
As both the employee and employer, you can make two types of contributions:
- As an employee: Set aside up to $23,000 in 2024 and $23,500 in 2025, with an additional $7,500 catch-up amount if youâre over age 50. For 2025, those age 60 to 63 can contribute an enhanced catch-up amount of $11,250, allowing total employee contributions of $34,750.
- As an employer: Add up to 25% of your businessâs net income (after deducting half of your self-employment tax), for a total of $69,000 in 2024 and $70,000 in 2025. Workers age 50 to 59 or 64 and older can contribute $76,500 in 2024 and $77,500 in 2025. Those age 60 to 63 can reach $81,250 in 2025 as part of a new enhanced catch-up amount.
Unlike a SEP IRA, which limits contributions to 25% of income, a solo 401(k) allows you to contribute the full employee limit in addition to the employer portion. This flexibility helps you maximize your retirement savings.
Comparing SEP IRAs and solo 401(k)s: An example
- Suppose Jane, 51, made $100,000 in 2024 as a freelancer and contributed 25% to her SEP IRA, or $25,000, hitting the SEP IRA income limit.
- Sally, also 51, also made $100,000, but she has a solo 401(k). Sally contributed $30,000 to the employee part of her 401(k) using her over-50 catch-up contribution, and another $25,000 as her employer limit, for a total of $55,000 (under the IRS limit for her plan, but much more than Janeâs contribution).
If you choose a solo 401(k) and your business grows beyond you and your spouse, remember that you canât add another employee to the plan. And if you own two businesses or work a second job, your limits are by person, not by job.
Comparison chart: SEP IRA and solo 401(k) plans | SEP IRA | Solo 401(k) |
|---|
| Allows catch-up contributions | No | Yes |
| Maximum contribution | $69,000 in 2024; $70,000 in 2025 | $69,000 in 2024 ($76,500 with catch-up); $70,000 in 2025 ($77,500 with catch-up or $81,250 for ages 60 to 63) |
| Contribution rates | Up to 25% of income | Employee portion: up to $23,000 in 2024 and $23,500 in 2025, plus a $7,500 catch-up ($11,250 for ages 60 to 63 in 2025). Employer portion: up to 25% of income. |
| Include other (non-spouse) employees | Yes | No |
| Roth version available | No | Yes |
As a self-employed person, you control your schedule and strategyâand your retirement savings can reflect that. Whether you choose a SEP IRA or a solo 401(k), these plans offer flexibility to suit your needs.
Unlike a company 401(k), which might limit your investment choices to a few mutual funds or one fund family, these plans give you ultimate discretion over your investments and allocation. Generally speaking, that means you get access to a much wider selection of investment choicesâstocks, bonds, exchange-traded funds (ETFs), and even some alternative investments are allowed.
Building a comfortable retirement typically involves combining Social Security with other sources of income.
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