SEP IRA vs 401k

By Ryan Johnson, Wealth Management Partner

One of the greatest advantages of being an independent contractor is the relatively large amount one can put away for retirement (in 2022 the max is $61,000*) and the significant tax savings that follow. Retirement may seem like a long way off or it may be right around the corner. In either scenario, understanding your retirement savings options is key. Every person’s strategy to becoming financially independent is unique, and it starts with 1) being educated on the options available to you, and 2) understanding how those options fit into your larger plan. See below for a baseline on what you can do to save as an independent contractor. For more advanced strategies, see Why Should I Hire My Spouse?, The 411 on Defined Benefit Plans, and The Buzz on Backdoor Roth IRAs.


This is the most simplistic tax-deductible plan for Independent Contractors. It is low cost, and there aren’t any additional required tax forms like the 5500 form. Many times, our clients set-up a SEP IRA because they run out of time to set-up (and fund) alternative accounts by the end of the calendar year. A SEP IRA allows you to set-up AND fund the account by your tax deadline. Filing an extension? That builds in some time as well. For example, we have some clients who in October of 2021 were setting-up and funding a SEP IRA for their 2020 tax year because they filed for an extension.

In this kind of account, you can put 20% of your income up to a max of $61,000 (as of 2022). Again, note, your contribution is tax deductible. To further illustrate this point, if you contribute $61,000, you can deduct that from your income. If that $61,000 is in the 24% tax bracket, you are saving around $14,000 in taxes.

Individual 401(k)

The maximum annual contribution limit for an individual 401(k), also known as a solo 401(k), is also $61,000 for 2022. One of the ways this differs from a SEP IRA is that if you are over the age of 50, there is a catch-up provision that allows you to put in another $6,500. Additionally, the formula in this plan allows you to get to the maximum quicker than the SEP IRA. In this scenario, you act as the employee and the employer. Therefore, you can contribute $20,500 plus 20% of your income up to $61,000 (or $67,500 if you are over the age of 50). Note – the $20,500 is an aggregate number across your plans. For example, if you also have w2 income where you are contributing to a retirement account, that contribution counts towards the $20,500. You do have to have this account set-up by the end of the calendar year, but you don’t have to fund it until your tax deadline (again, including extensions). This plan also requires some additional paperwork when tax time comes around.

A lesser known fact about the Individual 401(k) is that it also allows for loan availability. You can take out up to 50% of the account value (up to $50,000). When you take this loan, you pay back the interest to yourself. Many times people use this for real estate transactions when they need money for a down payment as they buy and sell.

Lastly, the individual 401(k) also allows for one to utilize a Backdoor Roth IRA. More on that in a subsequent blog.

So How Much Do I Really Need to Save?

It depends. Everyone’s path to financial independence is unique. All kinds of factors play into this answer like student loan debt, credit card debt, children, hobbies, travel expectations, second homes, inheritances, etc. Whether you are acting as your own financial adviser or using outside help, you should have access to a system that lets you input various factors outlining your current situation and future desired outcome. Knowing if you are behind, on track, or ahead is imperative to efficiently achieving financial independence. And don’t be scared of being behind… there are ways to catch-up beyond what we have outlined in this blog, like hiring a spouse or utilizing a Defined Benefit Plan.

Have financial questions? You can reach our financial advisers at Financial Designs, Inc by calling 888-898-3627 or simply make an appointment here:

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*$67,500 for age 50+


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