Retirement Savings


Are you hesitant to give up your full time employment position because you don't want to miss out on retirement savings? You shouldn’t be! In addition to the typical IRA options that everyone has access to, contractors gain access to two incredibly beneficial retirement options:  the SEP IRAs and the Solo 401(k).

Were you happy tucking away $18,500 into your employer's retirement plan? Well, with a SEP IRA or a Solo 401k, you will be able to save nearly 3 times that amount! That's right, in 2018, these plans allow you to contribute up to $55,000!

I'll get into the details about each plan below, but first, let me list out a couple of notes based on my experience:

  1. I set up a Solo 401(k) through Fidelity. Sure, there was a little bit of paperwork involved, but Fidelity helped me through the entire process.
  2. I pay no maintenance fees! The only costs are the per-trade fees that Fidelity charges in typical brokerage accounts.
  3. I'm not limited to a small list of mutual funds that my employer picks ahead of time - I can invest in literally anything that can be bought with a Fidelity brokerage account! This includes individual stocks, ETFs, and of course, Mutual Funds.

Okay, let's break down these two plans so you can find out which is best for you.

SEP IRA
A Simplified Employee Pension (SEP) IRA allows you to contribute up to 25% of your "Net Earnings from Self-Employment." Net Earnings is calculated as your Gross Income minus all deductible expenses, including the deductible portion of your Self-Employment taxes as well as your contribution to the SEP IRA.

That probably sounds messy, and there is a bit of work necessary to get this exact number. You can find a detailed explanation on the IRS website here:

However, as a quick rule of thumb, think of it this way. Your contribution limit will be roughly 20% of your total income.

If you have structured your business as an S-Corp, then this is a little more complicated. Net Earnings for a S-Corp owner consists of "Reasonable Salary" that you pay yourself, and it specifically excludes distributions. So keep this in mind - even though an S-Corp will allow you to save in Self-Employment taxes, it may reduce your maximum retirement contributions.

Solo 401(k)
A Solo (also Individual or Self-Employed) 401(k) has the same maximum contribution limit as a SEP IRA, but due to the way you contribute money, you can actually contribute MORE to your retirement account with LESS income.

Here's how it works. With a Solo 401(k), you are still limited to a contribution of 25% of your Net Earnings at the business level. However, you as an individual (or employee in the case of an S-Corp) will be able to make a separate personal contribution up to the normal 401(k) contribution limit ($18,500 for 2018). This personal contribution isn't included in the 25% limit. The two contributions combined can't exceed the overall maximum contribution limit ($55,000 in 2018), but you can definitely get closer to that limit with lower income.

Here are a few examples:

Net Earnings
$50,000
$100,000
$150,000
Maximum SEP IRA Contribution
25% of $50,000
= $12,500
25% of $100,000
= $25,000
25% of $150,000
= $37,500
Maximum Solo 401(k) Contribution
25% of $50,000
+ $18,500
= $31000
25% of $100,000
+ $18,500
= $43,500
25% of $150,000
 + $18,500
= $56,000
(Exceeds limit)

Another way of looking at this decision is this - how much income would you need in order to maximize your contribution with each plan?
With a SEP IRA, you would need $220000 in income in order to maximize your contribution.
With a Solo 401(k), you could hit the limit with just $146,000.

So a Solo 401(k) is clearly the best option, right? There is one (small) catch - a Solo 401(k) will require some additional annual paperwork once you reach an account balance of $250,000. Is that paperwork complicated enough to swing my vote over to the SEP IRA? Not at all. In my opinion, the Solo 401(k) is the way to go!

Last note:  If you have employees, or if you intend to hire employees in the near future, these plans probably aren't for you. If you use 1099 subcontractors exclusively, you may be golden.

Happy Contracting!

Jim Roberts