SIMPLE IRA Here's how three common retirement savings plans for self-employed workers stack up based on … An employer can contribute a 25% maximum of an employee’s pay to a SEP-IRA.#4. At the end of 2019, nearly 30% of American workers were self-employed, according to Gallup. One of the biggest benefits of being self-employed is that there are more (and better) retirement plan options available to you than are available to most taxpayers. Are you sure you want to rest your choices? A SIMPLE IRA … If you’re deciding between a solo 401(k) and a SEP IRA, and you have employees, the choice is easy: SEP IRA. A formal written agreement is required, known as IRS Form 5305-SEP, but the brokerage will usually take care of that. The deadline for the employer contribution is the due date (including extensions) for the business’s tax return for the year (i.e., April 15 of the following year, or October 15 if you filed for an extension). However, there are a few additional limitations to the above contributions. Simplified is in their name for a reason: They can be easier to set up than Solo 401(k) plans, according to Henry, and they’re more widely available. Comparing Self-Employed Retirement Plans: Solo 401(k) vs. SEP IRA vs. In most cases, an individual 401(k) plan will allow for the largest contribution. When comparing a SEP IRA to Solo 401(k), it’s important to know that business owners can make larger retirement contributions to a Solo 401(k) … He now writes The Red Tape Chronicles column at RedTape.Substack.com and hosts a podcast about the unintended consequences of technology. Articles are published Monday and Friday. SEP IRAs and SIMPLE IRAs, however, can sometimes be good choices because of their simplicity. The total contribution is limited to your net earnings from self-employment. In most circumstances you can contribute more — sometimes much more — to an individual 401(k) than you could contribute to a SEP IRA or SIMPLE IRA. The coronavirus pandemic has only accelerated the trend toward self-employment. He spent nearly two decades working at MSNBC.com and NBC News, and he still appears on TODAY, NBC Nightly News, and CNBC. Luckil… An individual 401(k) plan functions very much like a 401(k) plan with a person’s employer. For example, Fidelity’s individual 401(k) has no set-up or administrative costs at all. For a sole proprietor, this means that you can set up the plan and make contributions for a given year as late as April 15 of the following year (or October 15 of the following year if you filed for an extension). The SIMPLE IRA contribution limit is $13,500 with a catch-up limit of $3,000. If you have a SIMPLE IRA, you can make: For SIMPLE IRA purposes, “net earnings from self-employment” is your business’s profit, times 92.35% (to approximately account for your deduction for one-half of your self-employment tax). SIMPLE IRA vs. 401(k): The Pros and Cons of Each Plan For simplicity, employers might prefer the SIMPLE IRA. Now, since the Solo 401(k) is more popular, both plans are about equal in cost. The Most Significant Distinctions Between the SEP IRA vs Solo 401k The term IRA stands for “Individual Retirement Account,” one of the two most standard retirement accounts that any … To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. You are required to have a plan document, for instance. For instance, an entrepreneur who wants to put 10% of their net income into their SEP IRA must put 10% of worker pay into their SEP IRA, too. But even in some cases where hiring employees simply isn’t in the cards, Henry sometimes advises the self-employed to choose a SEP IRA. Accounting for exemptions, this works out to be about 20% of earnings for self-employed individuals, as calculated using IRS Publication 560. Specifically: Also, as we’ll discuss shortly, if you have another job (i.e., a “day job”), your maximum employee contribution and catch-up contribution will be affected if you make contributions to a retirement plan at that other job. If you ran a small business with only one other employee who was not your spouse, then, you would not be eligible to save for retirement in a Solo 401(k). SEP IRA Solo 401K SIMPLE IRA; Eligibility Requirements: Age 21 or older. Here’s the tricky part: Since the Solo 401(k) owner acts as both employer and employee, both types of contributions can be made—and that means most workers can contribute more and receive a higher tax break. Most major brokerages offer step-by-step instructions on their websites. Unemployment‌ ‌Benefits‌ ‌Boost‌ Calculator, Simplified Employee Pension Individual Retirement Account. Entrepreneurs who go with an SEP IRA because of potential future hires have another important consideration: All employee contributions must be the same percentage of compensation. Assuming you do not contribute to another retirement plan for your business, your annual SEP contribution will be limited to $18,587, calculated as 20% x ($100,000 — $7,065). What Exactly Can Be Taken From You In A Lawsuit? All Rights Reserved. Eligibility requirements are fairly straightforward: Anyone who generates net profits from a sole proprietorship, LLC or other business organization can open a solo 401(k) as long as they have no employees aside from their spouse. SEP IRA vs 401k: The Decision. Congress created the Simplified Employee Pension Individual Retirement Account (SEP IRA) in 1978 to extend the IRA concept to small businesses. SIMPLE IRAs also function much like traditional IRAs. Her net earnings from self-employment are $40,000. If you have an individual 401(k) plan (and no other retirement plans to which you’re contributing), your contribution limit will be $39,500 calculated as follows: If you had a SEP IRA instead, your contribution would be limited to $20,000 (20% of $100,000). Setting up an individual 401(k) will likely require you to fill out more forms than opening a SEP or SIMPLE IRA. But if you’re self-employed with no employees, the choice depends on how much you plan to save. Any business with one or more employees is eligible for a SEP IRA, including freelance workers and independent contractors. A catch-up contribution of $6,500 for 2020 if you’re age 50 or older. And the same goes for catch-up contributions. The term pension in this case is a bit archaic—a SEP IRA is not a defined benefit plan. Most of the retirement plan options for self-employed taxpayers function similarly to a traditional IRA. You have two excellent options: SEP IRAs and Solo 401(k) plans. Do You Need To Claim The Second Stimulus Check? In addition to usually allowing for greater contributions, individual 401(k) plans have another benefit: If you would prefer to do so, you can make Roth contributions to an individual 401(k) rather than pre-tax (“traditional”) contributions. Your particular situation will dictate which, the SEP IRA or Solo 401(k… To help support our reporting work, and to continue our ability to provide this content for free to our readers, we receive compensation from the companies that advertise on the Forbes Advisor site. So if you’re looking to have a small team, … Unfortunately, contributions are adjustments to income (i.e., “above the line” deductions) rather than Schedule C deductions, meaning they save you money on income tax but not self-employment tax. Employees are not permitted to make their own elective contributions, although a solo entrepreneur or self-employed person—who is in effect both employer and employee—may contribute acting as employer. In most cases, contributions to these plans reduce your taxable income. What Is The 4% Rule For Retirement Withdrawals? The Solo 401 (k), on the other hand, is great for anyone who is fully self-employed in a one-person business. The Solo 401(k) annual contribution maximum in 2020 is $57,000 and $58,000 in 2021. The employer contributions must be made as traditional, tax-deferred contributions. 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