Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Retirement Planning: A Standout Plan for the Self-Employed
Published Date : March 3, 2015
As financial advisors to a broad variety of clients, it is common for us to work with clients with all levels of career experience who are earning income as freelance or self-employed workers. While many of us are familiar with company-sponsored 401(k) plans and traditional IRAs, fewer of us are familiar with individual (or solo) 401(k)s and SEP IRAs. Self-employed individuals, particularly those who do not have employees (except perhaps a spouse working in the business), may want to consider reducing their net taxable income and maximizing annual tax deferred savings by establishing an individual 401(k) or SEP IRA (Simplified Employee Pension). While the two plans are similar in many ways, there are also important differences: for example, an individual 401(k) potentially allows larger contributions than a SEP IRA.
Individual 401(k)s have gained in popularity for the self-employed over the last few years and many significant financial service companies, such as Schwab and Fidelity, now offer plans. As a self-employed individual, the owner/operator is both an employee and employer of the business. As employee, he or she can contribute up to 100% of W-2 compensation, with a maximum of $18,000. That contribution limit rises to $24,000 for those over age 50. At the employer level, an additional profit sharing contribution is allowed of up to 25% of W-2 wages, or 20% of net business income. The combined maximum contribution limit of $53,000 per year jumps to a combined maximum of $59,000 for individuals over age 50 (Source: www.irs.gov). The dual status of the owner/operator as employee and employer is a feature unique to the individual 401(k) and results in an individual achieving the maximum contribution levels more quickly than is true under a SEP IRA. According to the IRS, individual 401(k)s also allow the participant to borrow up to 50% of the account balance, not to exceed $50,000, subject to guidelines on interest rates and terms. In effect, the business owner borrows from him or herself. The employee contribution to the 401(k) must be made by December 31st, while consistent with SEP IRAs employer contributions are due by the tax return filing date, even if the date is extended. With greater opportunity comes a degree of added complexity administratively.
By contrast, under a SEP IRA, self-employed individuals may contribute 25% of their W-2 earnings or 20% of net self-employment income, up to the $53,000 maximum (Source: www.irs.gov). Much like the individual 401(k), the account owner is not required to make annual contributions and therefore saving can happen when and if the business is profitable. Setting up a SEP IRA is just about as simple as opening a brokerage account. Ongoing administrative fees or responsibilities are minimal. Interestingly, SEP IRAs can be converted to individual 401(k)s with the plan custodian. Both individual 401(k)s and SEP IRAs are ideal tax deferred savings vehicles for the self-employed. Reaching the maximum allowable contribution more quickly is a clear benefit of individual 401(k)s.
Sand Hill Wealth Managers are happy to explore in more detail these retirement savings options to help determine the right choice for you.
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