Freelancer Retirement: Setting Up a SEP-IRA or Solo 401(k)

When you leave the corporate world to become a freelancer or solopreneur, you leave behind the 401(k) match and the HR department. You are now responsible for your own financial future. Fortunately, the tax code offers powerful tools for self-employed individuals to save for retirement while drastically reducing current taxable income. The two most popular contenders are the SEP-IRA and the Solo 401(k). Choosing the right one depends on your income level, your desire for administrative simplicity, and how aggressively you want to save.

Understanding the Contenders

Before looking at the math, you need to understand the fundamental structure of these two accounts.

What is a SEP-IRA?

A Simplified Employee Pension (SEP) IRA is straightforward. It functions largely like a traditional IRA but with significantly higher contribution limits. It is funded entirely by the “employer” (you) for the benefit of the employee (also you). It is known for having very little paperwork.

What is a Solo 401(k)?

A Solo 401(k), also known as a One-Participant 401(k) or i401(k), is a traditional 401(k) plan covering a business owner with no employees, or that owner and their spouse. Unlike the SEP-IRA, this plan allows you to contribute in two roles: as the employee (elective deferrals) and as the employer (profit sharing). This dual-role structure often allows freelancers to save more money at lower income levels.

Contribution Limits: The Math Breakdown

The primary reason to choose one over the other usually comes down to how much you can contribute based on your net income.

Key 2024 and 2025 Numbers:

  • 2024 Total Limit: $69,000
  • 2025 Total Limit: $70,000

While the total maximums are similar, how you reach them differs wildly.

SEP-IRA Calculation

With a SEP-IRA, you can contribute up to 25% of your compensation. For self-employed individuals, “compensation” is calculated as your net earnings from self-employment minus the deduction for one-half of your self-employment tax and the contribution itself. This effectively works out to about 20% of your net profit.

  • The Constraint: You cannot make personal “catch-up” contributions if you are over 50. The limit is strictly tied to a percentage of your income.

Solo 401(k) Calculation

The Solo 401(k) allows for two buckets of money:

  1. Employee Deferral: You can contribute up to $23,000 for 2024 ($23,500 for 2025) regardless of profit margins, as long as you earned at least that amount.
  2. Employer Profit Sharing: On top of the employee deferral, you can add 20% to 25% of your net business profit.
  3. Catch-Up Contributions: If you are age 50 or older, you can contribute an additional $7,500.

Scenario: The $100,000 Freelancer

To see which plan wins, look at a hypothetical freelancer earning $100,000 in net profit.

  • With a SEP-IRA: You can contribute roughly $20,000 (20% of net).
  • With a Solo 401(k): You can contribute your $23,000 employee deferral PLUS your $20,000 profit sharing. Total potential savings: $43,000.

In this scenario, the Solo 401(k) allows you to shelter more than double the income from taxes compared to the SEP-IRA.

Administrative Ease and Paperwork

While the Solo 401(k) wins on contribution math for many people, the SEP-IRA wins on simplicity.

SEP-IRA: The Low-Maintenance Option

Setting up a SEP-IRA is as easy as opening a standard brokerage account. You can do this at major providers like Fidelity, Vanguard, or Charles Schwab in about 15 minutes.

  • Form: You typically execute IRS Form 5305-SEP (usually handled digitally by your broker) and keep it for your records.
  • Annual Filings: None. You do not file a separate tax return for a SEP-IRA. You simply report the deduction on your personal 1040 tax return.
  • Deadline: You can set up and fund a SEP-IRA as late as your tax filing deadline (including extensions).

Solo 401(k): The Higher-Maintenance Option

The Solo 401(k) requires slightly more vigilance.

  • Setup: You must complete an adoption agreement. While brokers make this easy, it is a formal plan document.
  • EIN: You generally need an Employer Identification Number (EIN) from the IRS to open the plan, even if you are a sole proprietor who usually uses a Social Security Number.
  • The $250,000 Trigger: This is the most critical administrative detail. Once your Solo 401(k) plan assets exceed $250,000, you must file Form 5500-EZ with the IRS annually. Failure to file this form can result in significant penalties.
  • Closing the Plan: If you ever shut down your business, you must file a final Form 5500-EZ to terminate the plan, regardless of the balance.

Flexibility and Features

Beyond limits and paperwork, there are functional differences regarding what you can do with the money.

Roth Options

  • Solo 401(k): Many providers (such as Vanguard and E*TRADE) offer a Roth Solo 401(k) option. This allows you to pay taxes now on your employee deferral portion so withdrawals are tax-free in retirement.
  • SEP-IRA: Historically, SEP-IRAs were only pre-tax. While the SECURE 2.0 Act technically authorized Roth SEP-IRAs starting in 2023, major brokerage firms have been slow to update their systems to support them. For now, a SEP is almost exclusively a pre-tax instrument.

Loans

  • Solo 401(k): You are permitted to borrow against your Solo 401(k) balance (usually up to 50% of the account value or $50,000, whichever is less). This can be a safety net for business cash flow crunches.
  • SEP-IRA: Loans are not permitted. Any withdrawal before age 59½ is generally subject to taxes and a 10% penalty.

Making the Decision

Choose the SEP-IRA if:

  • You want the absolute minimum administrative burden.
  • You are a high earner (net income over $300,000) where the 20-25% calculation alone gets you close to the max contribution limit anyway.
  • It is tax season, and you missed the Dec 31 deadline to establish a Solo 401(k) for the previous year (though new rules have softened this, the SEP is still safer for late bloomers).

Choose the Solo 401(k) if:

  • You earn a moderate income ($60,000 to $200,000) but want to save a high percentage of it.
  • You want the option to make Roth contributions.
  • You want the ability to take a loan from your retirement funds if necessary.
  • You have a spouse who also works in the business (they can also contribute, effectively doubling the household limit).

Frequently Asked Questions

Can I have a Solo 401(k) if I also have a full-time job with a 401(k)? Yes. However, the “employee deferral” limit ($23,000 for 2024) is per person, not per plan. If you max out your 401(k) at your day job, you cannot make employee deferrals to your Solo 401(k). You can, however, still make the “employer profit sharing” contributions to your Solo 401(k) up to the total limit.

What happens if I hire an employee? If you hire a full-time employee (generally defined as working more than 1,000 hours a year) who is eligible for the plan, you can no longer use a Solo 401(k). You would have to convert it to a standard 401(k), which is expensive and complex to administer. If you plan to hire staff soon, a SEP-IRA is much easier to scale because you simply contribute the same percentage to their account as you do to yours.

Can I contribute to both a SEP-IRA and a Roth IRA? Yes. Your ability to contribute to a Roth IRA is based on your Adjusted Gross Income (AGI). Contributing to a SEP-IRA lowers your AGI, which might actually help you qualify for a Roth IRA if you are on the borderline of the income limits.

Does a “Backdoor Roth” affect my choice? Yes. If you plan to use the Backdoor Roth IRA strategy (contributing to a traditional IRA and converting it to Roth), having a large balance in a SEP-IRA will trigger the “Pro-Rata Rule,” making the conversion taxable. A Solo 401(k) does not count toward the Pro-Rata Rule, making it the preferred choice for high earners utilizing Backdoor Roths.