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Two Smart Retirement Plans for the Self Employeed

April 04, 2017

Self-employed folks have a variety of choices to set up retirement plans for themselves and their employees.  Today, we are going to talk about kinds of retirement plans that can give them the opportunity to contribute as much as $54,000 per year into a retirement account of their own.  This large contribution (contributions can be limited to net earned income) can lead to accumulating a nice nest-egg for your retirement. 


A SEP-IRA, or simplified employee pension individual retirement arrangement, is designed as a simple way for small-business owners to fund their retirement savings (and those of their employees, if they have any). A business of any size can set up a SEP-IRA, but these plans are most valuable for the self-employed without any employees, because the self-employed employer must contribute an equally large percentage of income to the SEP accounts of all eligible employees.  This can be a great perk for employees, but the business must balance this cost against profits sustained year after year.  If there are no employees, there’s nothing to worry about. 

  • What makes SEP-IRAs so great? The maximum annual contribution for a SEP-IRA is the lessor of 25% of your compensation (IRS defines this as earned income, which is after deducting Self-Employment Tax and SEP-IRA contributions) or $54,000 (in 2107). 

All contributions to a SEP-IRA are tax-deductible.  SEP-IRAs are much easier to set up and maintain than 401(k) plans and generally have lower fees and have no annual reporting requirements. 

Finally, SEP-IRAs have extremely flexible funding requirements.  You can contribute to a SEP-IRA at any time during the year or up to the filing of tax returns, including valid extensions.  That makes it easy to assess your business’s financial situation and your own before you decide how much to contribute.  If money is particularly tight, you can skip contributing altogether for the year. 

SEP-IRA distributions work much like other tax-deferred retirement plans.  You can’t borrow money from a SEP-IRA, but if you desperately need the funds, you can take an early withdrawal and pay the 10% (plus the 2.5% California penalty) pre-mature withdrawal penalty.  You can roll over the funds at any time into another variety of retirement account, assuming the new account permits rollovers.  Penalty-free distributions can begin at age 59 ½, and Required Minimum Distributions (RMD) commence on April 1 of the year after the year in which you reach age 70 ½. 

Solo 401(k) 

A Solo 401(k) (IRS calls it “The one participant 401(k) Plan) is like a traditional 401(K) except it is for a business with no employees.  It can be used for a husband and wife running their own self-employed business, or a couple of partners running their business without any employees.  The business owner(s) wear two hats in this plan: employee and employer. 

  • What makes a Solo 401(k) so great? Retirement contributions comprise two parts: (1) Employee, or Elective deferrals,  which include up to 100% of compensation, up to $18,000 or $24,000 if age 50 or older, and (2) Employer non-elective contributions of up to 25% of compensation as defined by the plan.  The maximum combined contribution limit is $54,000 (for 2017). 

Example: Bill, age 51, earned $50,000 in W-2 wages from his S Corporation in 2016.  He deferred $18,000 in regular elective deferrals plus $6,000 in catch-up contributions to the 401(k) plan.  His business contributed 25% of his compensation to the plan, for a total of $12,500.  Total contributions to the plan for 2016 were $36,500 (the sum of $24,000 and $12,500.  This is the maximum that can be contributed to the plan for Bill for 2016 (to reach the maximum contribution limit of $54,000, Bill’s compensation would’ve needed to be $120,000). 

Comparison to SEP-IRA: If Bill in the above example would have only had a SEP-IRA, he could only have contributed $12,500, as his employer contribution.  Thus, the for self-employed business owner, without employees, a Solo 401(k) offers a significantly larger contribution for the same compensation until the compensation gets high enough to reach the $54,000 limit (2017). 

All of the contributions to Solo 401(k) plans are tax deductible. 

Different from SEP-IRAs, Solo 401(k)s are required to file an annual report to the IRS on Form 5500-SE if the plan has $250,000 or more in assets at the end of year

Like SEP-IRAs, Solo 401(k)s follow the same accumulation and distribution rules explained above. 


 These two retirement plans, SEP-IRAs and Solo 401(k)s, offer the Self-Employed business owner a significant opportunity to save for their retirement in a tax-advantaged way.  The earlier in your work career that you start one of these plans the better prepared you will be for a successful retirement.


The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. 


#111 – Two Smart Retirement Plans for the Self-Employed


Sources: Internal Revenue Service, Chas Schwab and Putney Klein Associates, Inc.