It’s SEP to You
There are structures in place to encourage the self-employed to make their pension contributions.
The Simplified Employee Pension, or SEP, lets the self-employed contribute as much as 25 percent of their net self-employed earnings. There’s a cap of $57,000 in 2020, but it does provide a valuable way to put aside revenue on a tax-deferred basis and save for the future.
Setting up a SEP is relatively simple. The IRS provides a form to complete, after which you’ll need to open a SEP-IRA. You can do that at your local bank.
Like an employee, you can also create a 401(k) plan. Again, you can contribute up to 25 percent of your self-employed income up to $57,000 in 2020, but you can also pay in up to $19,500 from a salary.
You can even toss in an extra $6,500 if you’re over 50. Because that 401(k) plan only has one participant, it’s often described as a “solo-401(k)” or an “individual 401(k).”
There are other tax benefits that the self-employed can take advantage of, but those are the most important when it comes to retirement planning. These are the tools that entrepreneurs need to use to provide for their own futures.
The Pros and Cons of Self-Employed Retirement Funds
Clearly, self-employed retirement funds have advantages and disadvantages. On the one hand, they provide a way for entrepreneurs to put aside a significant part of their income until they’re paying tax at a lower rate. Because they’re the only participant, they also have more control over their 401(k)s and what they contain.
When you’re an employee, you get the 401(k) the company gives you. When you’re the boss, you get to make some choices.
As a self-employed boss, what you don’t get is matching contributions from someone else’s pocket.
When you’re an employee, the matching contributions look like free money. When you own the company, all of those contributions come out of your own pocket. There is no free money, and there’s no one to remind you to make those payments. Preparing for your future is something that you’ll need to remember to do yourself.