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). 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. Must have worked for the employer (yourself) in at least 3 of the last 5 years. Self-employment tax: What it is, why it exists, and how to calculate it. Most major brokerages offer step-by-step instructions on their websites. Alternatively, if you have a SIMPLE IRA, your contribution limit would be even lower ($13,500 plus 3% of net earnings from self-employment). Fortunately, you can use the “Deduction Worksheet for Self-employed” from IRS Publication 560 to walk you through the math. For side-hustle workers who don’t pay withholding taxes and worry about their end-of-year tax bill, the deduction can really help. The conclusion here? That is, contributions made to the plan reduce your taxable income, and your investments are allowed to grow tax-deferred until you start making withdrawals from the plan. To the best of our knowledge, all content is accurate as of the date posted, though offers contained herein may no longer be available. Over the last several years though, price competition has brought costs down considerably at some brokerage firms. Of that total contribution, $19,500 would be the salary deferral as an employee while $18,587 would be a profit sharing contribution as an employer. The conventional wisdom regarding the Solo 401(k) vs SEP IRA question is that self-employed people should choose the Solo 401(k) because in most cases, the potential tax savings are … A solo 401 (k) covers only a self-employed individual and their spouse (if they also work in … Individual 401 (k) … SEP IRAs and SIMPLE IRAs, however, can sometimes be good choices because of their simplicity. The opinions expressed are the author’s alone and have not been provided, approved, or otherwise endorsed by our. Your net earnings from self-employment are $100,000 for 2020. Unlike SEP IRAs, people age 50 and older can make additional catch-up contributions of $6,500 a year to a Solo 401(k), bringing the potential total to $63,500 ($64,500 in 2021). And it works in the other direction too — employee and catch-up contributions you make to an individual 401(k) or SIMPLE IRA will count against the contribution limits for your plan at work. You can unsubscribe at any time. Given the decline in costs, the only real remaining drawback is paperwork. Most of the retirement plan options for self-employed taxpayers function similarly to a traditional IRA. Second Stimulus Check Calculator: How Much Will You Receive? Annual fees, account minimums and investment options can vary more widely in a Solo 401(k) plan. Working for yourself doesn’t mean you have to miss out on the tax benefits that regular employees get from standard workplace retirement plans, though. Read customer reviews on Amazon, Corporate Finance Made Simple: Corporate Finance Explained in 100 Pages or Less The Takeaway: Solo 401(k) vs. SEP IRA. Retirement accounts such as the solo 401k plan, SEP IRA and SIMPLE IRA are popular choices for the self-employed because they are inexpensive to establish, maintain and minimum IRS reporting applies.. Solo 401(k)s also offer catch-up contributions for people 50 and older as well as a Roth option, which lets you pay income tax now in exchange for tax-free withdrawals in retirement. The only really important difference is the contribution limit. EXAMPLE: Your business’s profit for the year is $100,000, and your deduction for one-half of your self-employment tax is $7,065. Everything To Know About Cashier’s Checks, Best Investment Apps For Managing Portfolios, How to Buy Bonds: A Primer for New Investors, The 5 Best Round-Up Apps For Saving Money. When you work for an employer, you can usually count on there being a 401(k) plan or something similar already in place that you can contribute to. The ranks of self-employed Americans are growing. So today there are pros for using a SEP. 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. A Solo 401(k), however, is a more complex beast than a SEP-IRA. (For more information, see the book on Amazon: Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less.). Solo 401(k) plans also allow you to make post-tax Roth contributions. For 2020, if you have a SEP, you are allowed to contribute the lesser of: Once the money is in the plan, you can invest it in all of the same things you would be allowed to invest in with a regular IRA (stocks, bonds, mutual funds, CDs, etc.).