While completing my taxes in prior years, I started noticing that I would have a not insignificant tax bill due from self-employment and side project income unless I found a way to reduce my taxable income (especially with full-time employment income in the mix).
Our (Mrs. 20SF and I file jointly) income levels were beyond where I could contribute to a Traditional IRA (we were above the IRA contribution limits) – so that was not an option. And contributing to a Roth IRA (after-tax) would have defeated the whole purpose of reducing taxable income.
So, after a number of years of running this site and having (mostly tiny) side self-employment income beyond my day job, I decided to look in to retirement plans for self-employment income. “Self-employment” is a big word, but any sort of side income you get from projects, hustles, real estate income, etc. could apply.
I found three retirement plan options, which I’ve highlighted separately here:
In today’s article, I’ll chart the differences between the three.
Note: I also have done a separate ranking of the best retirement accounts for non-self employment income that you may want to also check out.
Self-Employed Retirement Plan Options
Before I get to which plan I chose to create and why, I compiled a chart that compares the self-employed retirement plans against each other.
|SEP IRA||Solo 401K||SIMPLE IRA|
|Eligibility Requirements||Age 21 or older. Must have worked for the employer (yourself) in at least 3 of the last 5 years. Must have received at least $600 (2020) or $650 (2021) in compensation.||No employees (outside of spouse). No age or service restrictions.||No age restrictions. Must earn a minimum amount specified by the employer during any 2 of 5 preceding years, & expect to earn at least $5,000 in the current year.|
|Maximum Contributions as Employee (Self-Employed)||Personal contribution of up to $6,000 ($7,000 for employees age 50+) in 2020 & 2021 into an individual SEP, Traditional, or Roth IRA. Income restrictions apply.||$19,500 ($26,000 for employees age 50+) in 2020 & 2021. Cannot exceed 100% of compensation.||$13,500 ($16,500 for age 50+) in 2020 & 2021.|
|Maximum Contributions as Employer (Self-Employed)||25% of net earnings up to $57,000 for 2020 & $58,000 for 2021. Deductible up to 20%. Annual contributions not required.||For self-employed, 25% of net earnings up to $57,000 for 2020 and $58,000 for 2021. Deductible up to 20%. Annual contributions not required.||Option 1: Match up to 3% of compensation (can be reduced to as low as 1% in any two out of 5 years) or $13,500 (2020 & 2021), whichever is less.
Option 2: Contribute 2% of income (max contribution of $5,700 in 2020, $5,800 in 2021).
Contributions are required every year.
|Roth Option Possible?||No||Yes (employee contributions). Availability varies by broker.||No|
|Rollover Options||SEP, Roth, & Traditional IRAs, Qualified pre-tax plans (401K, 403B, 457B).||SEP, Roth, & Traditional IRAs, Qualified pre-tax plans (401K, 403B, 457B).||SEP, Roth, & Traditional IRAs, Qualified pre-tax plans (401K), 403B, 457B if after 2 years have passed from employee first participation. No waiting period for rollover to another SIMPLE.|
|Broker Availability||Highest availability of the 3 plans. Most discount brokers have a SEP IRA account option.||Lowest availability of the 3 plans. Roth contribution option varies by broker.||Middle availability of the 3 plans.|
|Administrative Responsibilities||Complete IRS form 5305-SEP (broker handles). No IRS reporting required.||Annual filing of Form 5500-EZ may be required.|
Plan sponsors have various administrative & fiduciary responsibilities.
|Complete IRS form 5304-SIMPLE or 5305-SIMPLE (broker handles).
No IRS reporting required.
SEP IRA vs. Solo 401K vs. SIMPLE IRA
Everyone’s personal situation is different and there is no single definitive superior retirement plan for every individual who earns self-employment income.
So how do you choose?
Your primary considerations should be:
- Do you have a 403B, 401K, or other qualified retirement plan through an employer?
- What level of self-employment income do you earn?
- How much do you want to contribute?
- How much administrative responsibility are you comfortable with?
- What are the associated fees and investment options with each plan?
If the answer to #1 is “no”, then the Solo 401K gives you the highest contribution limits, as it effectively combines the $19,500 (2021) employee contribution with the additional ability to contribute 25% of net earnings as employer. However, it does have the drawbacks of more administrative responsibility and limited broker availability (and potentially higher administrative fee costs). If you are not earning at higher levels, the increased contribution limits might not be worth it, with the drawbacks in mind.
From there, it’s a matter of how much you’d like to contribute, availability, fees, and investment options when choosing between a SIMPLE and SEP.
If the answer to #1 is “yes”, then the SEP IRA is the clear cut winner, in my opinion. Keep in mind that any contributions you make as an employee to a Solo 401K or SIMPLE IRA count against the maximum employee contribution limits and are cumulative between accounts, so the full contribution to a SIMPLE IRA as an employee would have no added benefit. You would be better off simply contributing to your employer’s sponsored plan for the employee contribution aspect, especially if a 401K match is involved. And for contributions with the status of “employer” the SEP IRA contribution limits are far higher than the SIMPLE IRA limits. SEPs also have greater discount broker availability and typically more investment options than SIMPLE IRAs.
Self-Employed Retirement Plan Calculators
It might also be beneficial to use a calculator to help you figure out which plan might result in the most tax deductible contributions for you. Here are a few retirement plan calculators that can lend a hand:
- Vanguard’s retirement plan contribution calculator
- TD Ameritrade self-employment plan calculator
- CalcXML retirement plan calculator
Self-Employed Retirement Plan Discussion:
Which retirement plan do you use for your self employment income? And why?