Self-Employed Retirement Plan Comparison: SEP IRA vs Solo 401K vs SIMPLE IRA

While completing my tax return 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. This was especially true for a number of years when I was receiving full-time employment income on top of side-project income.

Our (Mrs. 20SF and I file jointly) income levels were above the IRA contribution limits, so we could not contribute to a Traditional IRA. And contributing to a Roth IRA (after-tax) would have defeated the whole purpose of reducing our 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 income you get from projects, businesses, side income, real estate income, etc. could apply.

I found three retirement plan options for self-employment income, which I’ve highlighted in-depth separately in the following articles:

  1. SEP IRA
  2. Solo 401K (AKA a “one-participant 401K” or “individual 401K”)

In today’s article, I’ll chart the differences between the three for a full comparison.

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 explain which plan(s) I chose to create and why, I compiled a chart that compares the self-employed retirement plans against each other.

Eligibility RequirementsAge 21 or older. Must have worked for the employer (yourself) in at least 3 of the last 5 years. Must have received at least $650 (2021 & 2022) 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) or "Individual""Individual" contribution of up to $6,000 ($7,000 for employees age 50+) in 2021 & 2022 into an individual SEP, Traditional, or Roth IRA. Income restrictions apply."Employee" contribution up to $19,500 ($26,000 for employees age 50+) in 2021 or $20,500 ($27,000 for employees age 50+) in 2022. Cannot exceed 100% of compensation."Employee" contribution up to $13,500 ($16,500 for age 50+) in 2021 & $14,000 ($17,000 for age 50+) in 2022.
Maximum Contributions as "Employer"25% of net earnings up to $58,000 for 2021 & $61,000 for 2022. Deductible up to 20%. Annual contributions not required.25% of net earnings up to $58,000 for 2021 and $61,000 for 2022. 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 (2021) or $14,000 (2022), whichever is less.
Option 2: Contribute 2% of income (max contribution of $5,800 in 2021, $6,100 in 2022).
Contributions are required every year.
Roth Option Possible?NoYes (employee contributions only). Availability varies by broker.No
Rollover OptionsSEP, Roth, & Traditional IRAs, Qualified pre-tax plans (401K, 403B, 457B). Tax implications may apply.SEP, Roth, & Traditional IRAs, Qualified pre-tax plans (401K, 403B, 457B). Tax implications may apply.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. Tax implications may apply.
Broker AvailabilityHighest 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 ResponsibilitiesComplete 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. I started a SEP IRA while I had an employer-sponsored 401K while working full-time for an employer. After I left that employer and became fully self-employed, I then created a Solo 401K.

So how do you choose?

Your primary considerations should be:

  1. Do you have a 403B, 401K, or other qualified retirement plan through an employer?
  2. What level of self-employment income do you earn?
  3. How much do you want to contribute?
  4. How much administrative responsibility are you comfortable with?
  5. 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 maximum employee 401K contribution ($20,500 for those under age 50 or $27,000 for those age 50 and over) with the additional ability to contribute 25% of net earnings as employer. These combined employee and employer contributions give the Solo 401K the highest contribution amount of the three types of self-employment accounts. However, the Solo 401K does have the drawbacks of more administrative responsibility, limited broker availability (and potentially higher administrative fee costs), and even limited investment options compared to the IRA options. If you are not earning at higher levels, the increased contribution limits might not be worth it, with those 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 your annual “employee” contributions are covered. In this case, 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 and 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 or Solo 401Ks.

self employed retirement plans

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:

Self-Employed Retirement Plan Discussion:

Which retirement plan do you use for your self employment income? And why?

Related Posts:

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