Retirement Plan Options for the Self-Employed

If you're self-employed, you need to establish and fund your own retirement savings program.


One of the major issues facing the self-employed is how to save for retirement. If you work for a company you likely have a 401(k) plan or other retirement savings plan available to you. If you are self-employed, you will need to establish and fund your own retirement savings program. Two options to consider are the Solo 401(k) and the SEP Individual Retirement Account (IRA).

Here are some of the features of both:

Annual contributions. Limits for the Solo 401(k) are $49,000 ($54,500 if you are 50 or over at any point in 2011). Limits for the SEP IRA are $49,000 with no catch-up provision for those 50 and over.

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The Solo 401(k) has two components: the 401(k) portion and the profit sharing component. The 401(k) component contribution limits are $16,500 ($22,000 for those 50 and over). The profit sharing component is calculated separately with limits up to an additional 25 percent of your compensation to a combined maximum of $49,000 ($54,500 if 50 or over). The combined contributions must be made by your tax filing date including extensions.

Flexibility. The SEP IRA offers slightly more flexibility. The Solo 401(k) plan must be established by the end of the calendar year (or fiscal year if applicable)—for example by Dec. 31, 2011 in order to make a 2011 contribution.

The SEP IRA must be established and funded by the date your tax return is filed, including extensions. For example, you can establish and fund a new SEP IRA by Oct. 15, 2012 and still take a 2011 deduction if you are a Schedule C taxpayer. Consult your tax professional regarding your specific situation.

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Maximizing contributions. If your goal is to maximize your contributions, the Solo 401(k) will be the better choice in most instances. Depending upon your plan document, the 401(k) portion can be as high as 100 percent of your W-2 earnings or your Schedule C income.

The SEP IRA contributions are always a percentage of your W-2 income or Schedule C earnings meaning that in lean years your maximum contribution to the plan might be lower than you would like, even if you have outside resources to draw upon.

Employee plans. If you hire employees, the Solo 401(k) might not work for you. However, in general, a spouse or a business partner is allowed.

With the SEP IRA, the cost to fully contribute to your own account might become prohibitive in that you essentially do the same for your employees as you do for yourself.

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In both cases, sole proprietors, corporations, and LLCs are all eligible to open either type of plan.

Other similarities and differences between Solo 401(k) and SEP IRA plans include:

  • Loans are available from Solo 401(k)s, but not with SEP IRAs.
    • A Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP IRA.
      • Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the level of annual government paperwork increases a bit.
        • Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
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          Besides the Solo 401(k) and the SEP IRA, the self-employed have several other options available to fund their retirement ranging from IRAs (Traditional and Roth), SIMPLE plans, and pension plans (including cash balance plans). Talk to your tax and financial adviser to determine what is right for your situation.

          Being self-employed has many rewards, but can also entail a lot of work and a significant time commitment. To the extent that you can, start a retirement plan for yourself or fund an existing plan. You deserve it.

          Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill. where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.

          Corrected on 9/14/2011: A previous version of this article misstated the deadline for making Solo 401(k) contributions. Contributions must be made by your tax filing date (including extensions), not by the end of the calendar year.