Are you self-employed? Do you work as a contractor, a consultant, or otherwise receive compensation that you must pay self-employment tax on? There are special retirement savings plans available just for you!
CNN Money has a detailed description of the retirement plans available to the self-employed.
Many authors have advice for choosing a plan:
If you have employees, the SEP-IRA is the only option.
If you have a sole proprietorship or a partnership with your spouse, the Solo 401(k) is usually the better option. SEP-IRA contributions are included in pro rata taxability calculations while Solo 401(k) contributions are not, giving Solo 401(k) holders an advantage when making backdoor Traditional-to-Roth IRA conversions.
While the Solo 401(k) and SEP-IRA appear to have the same overall maximums, maximum annual contributions are calculated in very different ways. The Solo 401(k) will almost always allow more contributions than the SEP-IRA!
In either plan, you can also deduct half of the self-employment tax and contribute that as well! If you can contribute your entire self-employment income, you could theoretically only pay the employer half of the self-employment tax. Otherwise, you’d pay the entire self-employment tax and then income tax on top of that.
Also called the Individual 401(k). If you are a sole proprietor or run a partnership with your spouse and want to put away a bunch of money for retirement, this is the way to do it.
Plans are offered by several major brokerages:
“$20 per year for each Vanguard fund held in a Vanguard Individual 401(k) account. If at least one participant qualifies for Flagship, Voyager Select, or Voyager Services, the account service fee will be waived for all participants in the plan.”
Details on Vanguard Voyager and Flagship services:
“Eligibility is based on total household assets held at Vanguard, with a minimum of $50,000 to qualify for Vanguard Voyager Services®, $500,000 for Vanguard Voyager Select Services®, $1 million for Vanguard Flagship Services®, and $10 million for Vanguard Flagship Select Services™. We determine eligibility by aggregating assets of all qualifying accounts held by the investor and his or her immediate family members who reside at the same address, including investments in Vanguard mutual funds, Vanguard ETFs®, certain annuities through Vanguard, The Vanguard 529 Plan, and certain small-business accounts. Assets in employer-sponsored retirement plans for which Vanguard provides recordkeeping services may be included in determining eligibility if the investor also has a personal account holding Vanguard mutual funds. Vanguard ETFs and Vanguard mutual funds held in a Vanguard Brokerage Account are also included when determining a household’s eligibility; other assets held in a brokerage account are not.”
Contribution Limits
$17,500 in employee elective deferrals + employee nonelective contributions, matching, etc < $51,000
It’s entirely possible to have both a Solo 401(k) and a regular employer-sponsored 401(k) at work.
Solo 401(k) Contribution Limits
“Unlike the traditional 401k, the self-employed 401k allows owners to contribute up to 25% of their annual pay to themselves in the form of profit-sharing. For most people, the two forms of contributions can add up to a maximum of $46,000 a year, under 2008 rules, although people aged 50 and over are allowed to put away as much as $51,000 a year. Perhaps the best part: In combination, the two forms of contributions can add up to 100% of an owner’s income if they fall under these limits.”
Stands for Simplified Employee Pension. If you run a small business and want to provide a retirement plan for your employees, use this.
Contribution Limits
25% of the employee’s compensation or $51,000
Vanguard’s Individual SEP-IRA plan: https://investor.vanguard.com/what-we-offer/small-business/sep-ira
“$20 per year for each Vanguard fund with an account balance less than $10,000. Fee does not apply to Flagship, Voyager Select, or Voyager Services clients or shareholders who have signed up for paperless communications.”
From Internal Revenue Manual, Part 4, Chapter 72, Section 17 - SEPs and SARSEPs:
"A SEP is treated as a defined contribution plan for purposes of the limitations under IRC 415."
"Under IRC 404(h)(1)(C), an employer cannot deduct contributions that exceed 25 percent of employees’ compensation for the year"
"Also, under IRC 402(h), a SEP participant cannot exclude from gross income SEP contributions that exceed 25 percent of compensation."
"The compensation upon which the 25 percent is based cannot exceed $260,000 (for 2014) and under IRC 402(h)(2) it does not include any elective deferrals or other amounts not includible in gross income."
"Net earnings from self-employment for SEP purposes means gross income from the business minus allowable deductions for that business (net earnings). For SEP purposes, net earnings must take into account the deductions for contributions to the self-employed individual’s own SEP. Because the deduction amount and the net earnings amount are each dependent on the other, this adjustment presents a problem. To solve this problem, adjustments are made indirectly by reducing the contribution rate called for in the plan, in figuring the maximum deduction."
Employer Profit-Sharing Contributions 1:
20% of net adjusted self-employment income, up to a maximum of $260,000 in income
net adjusted self-employment income = gross income - business expenses - employer’s half of payroll taxes
It’s entirely possible to have a SEP-IRA and still make regular contributions to a Roth or Traditional IRA!
Pronounced ‘key-oh’. They are paperwork-heavy and were largely supplanted by SEP IRAs due to tax law changes in 2001.
What is the absolute maximum it would be possible to contribute to tax-advantaged retirement plans in 2014 if you worked at an employer AND had a side-business?
| Account Type | Annual Limit, 2015 |
|---|---|
| Roth IRA | $5,500 |
| 401(k)/403(b) | $18,000 + Matching |
| 457(b) | $18,000 |
| Solo 401(k) | $53,000 |
| Grand Total | $94,500 |
If you and your spouse both work and are both in on the Solo 401(k), then double these numbers!
In most cases, the Solo 401(k) has a higher practical contribution limit because a SEP IRA would be limited to 20% of adjusted self-employment earnings.
“To figure out your net adjusted self-employment income, the IRS recommends taking your gross income, subtract business expenses (the tricky part is that business expenses should include SEP IRA contributions) and subtract half of the self-employment tax.”
This Bogleheads forum post features several self-employed people discussing the practical difficulties of setting up a Solo 401(k):
“I have my solo 401k (with profit sharing) through Vanguard. Easy to use….no cost…..it’s all done on-line - even the monthly contributions. No administrative headaches.”
“I have an I401k at Vanguard - and previously had one at Price. The initial application paperwork is definitely longer, but the instructions are reasonable clear. Operation of the I401k is just like an IRA, with the exception (the last I knew) that contributions must be made manually via check. No auto contributions, etc. Being able to tuck a large amount of money into the I401k certainly makes up for the slight extra hassle.”
“I’ve spent the past week researching the Solo 401k and with Vanguard and Fidelity inexpensive plans you do *NOT* get the Roth 401 component in the plan docs. You will need to buy a full plan from a “pension plan consultant”/third party administrator. You may pay a little extra for the ability to get a loan component added. “
“I just establish my Vanguard Individual 401K and I have the ROTH component in my Vanguard Individual 401K.”
“The plan permits three types of contributions: employee individual (pre-tax) salary deferral, employee Roth (after-tax) salary deferral, and employer traditional (pre-tax).”
“I have a Solo 401K with Roth option directly with Vanguard. I also have another one with T. Rowe Price (because they offered one a few years before Vanguard did). There is one additional page of paperwork you have to fill out to declare you want the Roth component. Not a big deal.”