Absolutely. Whether you're a freelancer, independent contractor or budding entrepreneur, you have access to an expanded range of retirement plans, including both an
Individual 401(k) and a SEP IRA. These plans offer higher contribution limits than traditional IRAs, with possible tax advantages depending on your personal situation.
Retirement contribution options for small businesses |
| |
Individual 401(k) |
SEP IRA |
| Who's it for? |
Small business owners with no employees (other than spouses who work for the business) and the self-employed |
Small business owners (and their eligible employees) and the self-employed |
| Who can contribute? |
Employer (you) and employee (you or your spouse) |
Employer (you or your spouse)Footnote 1 |
| Maximum contribution?Footnote 2 |
Employee contributions of up to $19,500 ($26,000 if age 50+ at any time during the calendar year), employer contributions up to 25% of eligible compensation (or, for self-employed individuals, 20% of net earnings from self-employment), up to a combined amount equal to the lesser of (i) the employee's compensation for the year, or (ii) of $58,000 ($57,000 for 2020) (not counting catch-up contributions for those age 50+) |
Employer contributions limited to the lesser of (i) 25% of eligible compensation (or, for self-employed individuals, 20% of net earnings from self-employment), or (ii) $58,000 ($57,000 for 2020) |
|
Footnote 1 This article does not address SARSEPs (or salary reduction SEPs) that allowed employee contributions but had to be in place as of December 31, 1996.
Footnote 2 For additional information on calculating maximum contributions, consult your tax advisor.
|
How does an Individual 401(k) work?
An Individual 401(k) — also known as a Solo 401(k) — is designed for business owners without employees, although spouses may participate if they work for the business. With an Individual 401(k), you decide how much to contribute, within limits, and you can choose to contribute as your cash flow allows.
Your business generally can deduct contributions you make to an Individual 401(k) as the employer subject to certain limits. You also may contribute as an employee, which may reduce your federal taxable income. Total combined contribution limits as employee and employer, set at an amount equal to the lesser of (i) the employee's compensation for the year, or $58,000 for 2021 (or $64,500 if you are over age 50 at any time during the calendar year and eligible for catch-up contributions), are significantly higher than contribution limits for a traditional IRA.
Are there other types of Individual 401(k) plans?
If you decide to open an Individual 401(k), you can utilize traditional contributions, Roth contributions, or both. Perhaps the major difference between them is that traditional 401(k) contributions are made with pre-tax dollars, while Roth 401(k) contributions are made with after-tax dollars. Once five years have passed since the tax year of your first Roth 401(k) contribution to the plan, you can benefit from federal income tax-free withdrawals once you reach age 59½. If traditional or Roth 401(k) assets are withdrawn prior to reaching age 59½, an additional 10% federal tax may apply to the taxable portion of the withdrawal, unless an exception applies.
What about a SEP IRA?
As a 1099 contractor, you also might consider a
Simplified Employee Pension (SEP) IRA as a retirement plan option. Contributions to individual accounts under a SEP IRA plan are generally tax-deductible by your business, and you may contribute the lesser of (i) $58,000 for 2021 ($57,000 for 2020 up to your tax filing deadline plus extension, if any), or (ii) 25% of eligible compensation (or, for self-employed individuals, 20% of net earnings from self-employment). However, you might have the opportunity to contribute more to an Individual
401(k), through salary deferrals and employer contributions, than to a SEP IRA, which is eligible for employer contributions only. This is because the contribution limit of 25% of compensation (or, if you are self-employed, 20% of your net earnings from self-employment) only applies to employer contributions, not salary deferrals. Be sure to consult your accountant or tax professional for advice on the contribution level and retirement account type that may be right for you.