SEP IRA or 401K for Self-Employed?


#1

Hey guys,

I just started freelance consulting this year, and I’m trying to figure out the best way to optimize my tax-sheltered investing.

I’m far from being a tax-whiz, but it looks like if I go the 401K route, I can contribute upwards of 36K for myself, but less for a SEP.

Any other US freelancers out there with experience here? My husband says it can be expensive and a pain to set up a private 401k, but I can’t imagine it’s that hard.

Would love any thoughts on this!


#2

A solo 401k with one of the big brokerages takes filling out a form and mailing it in. There is no cost except trades for fidelity or schwab.

The benefit of the solo over the sep is primarily you can put in you 18.5 k self amount if you haven’t done so via you employer. Both allow profit sharing of 20 percent separately.


#3

I’ve been self-employed for nearly 20 years and over those years have had time with both plan options.

First, I assume you have no employees, correct? If you do, they would almost always need to be included in the plan(s).

SEP’s are nice because they are easy to set up and cheap/easy to administrate. 401k’s do require a bit more work, but places like Vanguard can set up a solo-401k type plan for $0 (or at least they did when I set my plan up). You can pair the 401k with a profit sharing contribution, too.

Depending on your income, 401k’s often allow a bigger contribution. For example, if your company is an S-Corp and you pay yourself $50,000 on a W-2. A SEP is limited to 25% of the $50k, or $12,500. With a solo-401k, you could defer $18.5k or $24.5k depending on your age. Plus, the company could make a profit sharing contribution of 25% of the $50k, or $12,500. So the total contribution could be up to $31k (or $37k if 50 or over). The SEP and profit sharing contributions are discretionary, so they are not required each year (just in case the profitability is low one year).

John


#4

Wow, this is super helpful, John. Thank you, I am my only employee so this sounds right for me.

Thx again!


#5

Thanks @FullTimeFinance! This is exactly what I wanted to know!!!


#6

I wrote a post about this when I was debating which one for self employed. i401k sounds like the right choice, but in case you’re interested in the nitty gritty here:


#7

Not expensive. Not a pain. I have a Solo 401(k) and it was a tremendous wealth builder last year. I have mine with Vanguard which is fine but I have heard that ETRADE is even better. Enjoy keeping more of what you earn!


#8

Perfect! Thx


#9

Oooh good to know! So were you allowed to contribute the full $36 k for yourself?


#10

I highly recommend setting up a Solo 401k with Fidelity. Interestingly, they actually have Vanguard beat on the Solo 401k front, since there are no fees with their Solo 401k and no trading fees when you buy Fidelity Mutual Funds. A Fidelity Total Stock Market Index Fund like FSTVX only charges 4 basis points. I wrote a post about how to set up a Fidelity Solo 401k last year, if it helps:


#11

I think I was allowed $23k. It is 25% of the net income. I had only been a 1099 for half the year so I didn’t have as big of a net as I needed to do the full amount. But I shielded an extra $23k from taxes so that is a huge win!


#12

Definitely go with the personal 401K.

You can contribute a lot more money. Which means more tax deferred money, and lower taxes (your contribution lowers your taxes).

Easy to set up. I used Vanguard. Has the lowest fees for funds and ETFs.


#13

thank you! I really appreciate that. I’ve heard Etrade doesn’t charge fees, either.


#14

Definitely. How did you figure out that you were allowed 23K? Did you wait until the end of the tax year to determine that figure and invest? I heard it’s not a good idea to guesstimate these things.


#15

Thank you!! I’m defiantely sold on the 401K :slight_smile:


#16

The amount is based on your self-employed income for the year. No guessing needed.

There are calculators to use that tell you. Here is Fidelity’s:
https://scs.fidelity.com/products/mobile/sepMobile.shtml

Another one:

You can also try some others, all should give about the same answer, use Google to search


#17

thank you!!


#18

My accountant did an estimate with me. He also said not to stress too much because you can file a correction with your tax return (not sure if that is the write word) if you go over the limit. The big win is setting it up and contributing, then optimize.


#19

agreed! thanks again.