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Why Should Independent Contractors Use a Solo 401K for Asset Management? (Updated Dec. 2022) Thumbnail

Why Should Independent Contractors Use a Solo 401K for Asset Management? (Updated Dec. 2022)

Retirement Funding Insights

Why Should Independent Contractors Use a Solo 401K for Asset Management?

Topics: Simple IRA, SEP, Solo 401K, Roth 401K, Spousal Contributions, Catch up Contributions, Checkbook Control

My operational focus has been to pursue clients like me, that have similar life experiences. That’s most of Gen X and Gen Y, the group currently in the “sandwich generation” where we are considering the needs of our parents and of our own children. We might be thinking about how to pay off student loans while thinking about how much to save for our kids’ college education. We might be thinking about finding fairly priced health care insurance, while considering the challenges or costs of long-term health care for our parents. We might be thinking about how can we possibly save for retirement when it’s so far away while also dealing with the bills of today. It’s a lot to manage. The considerations for our finances are pretty spread out, and thus the need to have a Financial Plan.

Besides having similar-ish age as potential clients (let’s say +/- 15 years), I seek to serve individuals that have similar Retirement Plan needs as I do. The entrepreneur, the self-employed, those that get paid with a 1099 – the Independent Contractor. A book I read (The Million-Dollar One-Person Business) mentioned out of about 28 million small business in America, 23 million were “non-employers,” meaning just one individual worked there (citing 2016 government statistics). I wonder how these people are saving for retirement? Now, add this group to Independent Contractors, and this is the exact group I’m talking to (plus those with an income-producing side-hustle). We have advantages of saving not offered to most employees. There is a wide array of Retirement Plan savings vehicles available to us, and while I’ll mention a few of them, the best remains the Solo 401K.

In this post I follow my recent series of posts where I apply new ideas to old blog topics. In my last post I wrote about how $1 million may not be worth that much in retirement. I’ve discussed the topic of why I favor the 401K plan in several posts, focusing on its benefits for both Real Estate agents and for Small Business owners, and today I wanted to address why the Solo 401K is an ideal savings tool for Independent Contractors by comparing and contrasting several popular plans.

Retirement Plan options for individuals:

  1. Simple IRA
  2. Simplified Employee Pension (SEP)
  3. Solo 401K

Before we get into the details:

On a personal note

I’ve mentioned a few times on the blog, that I utilize a Solo 401K. Among the three types of plans I’ll discuss (Simple, SEP, Solo), the Solo is the plan that will ultimately allow me to maximize my savings and minimize my tax burden. The flexibility is advantageous too, with the ability to contribute in varying amounts relative to your income, borrow, or contribute after paying taxes. The downside could be (but not necessarily) higher administration cost (depending on how its structured and how much control you want) and plan setup must occur earlier than other plans (by the Dec. 31 of the year you want to make contributions). But for my near-term plan, the Solo remains the best, and I think it does for Independent Contractors as well, but let’s discuss the options thoroughly.

Simple IRA

It is what it says – simple. Sometimes simple is good, like in terms of setup and ongoing administration. However, the limit to contribute in 2022 is $14,000 ($15,500 in 2023). While that’s more than twice the contribution limit for a traditional IRA ($6,000 in 2022, $6,500 in 2023), it remains a fraction (less than 25%!) of what an Independent Contractor or Self-Employed person can put in a SEP or a Solo 401K. The Simple does offer a $3,000 catch up contribution (so $17,000 total) for those over 50. However, if your goal is to maximize savings and you have the income to do it, the Simple is simply inadequate. However, if you have a fairly steady business and lower contributions are all you need, then a Simple might make sense, but as income grows, you will want to update your plan to make sure you are able to hit your target savings rate of at least 15%.

SEP (Simplified Employee Pension)

The SEP is another common tool used for retirement by the self-employed. Setup and administration is mostly straight-forward though you must fill out IRS Form 5305-SEP. Contribution limits for the SEP of $61,000 in 2022 ($66,000 in 2023) dwarf the Simple and are comparable to the Solo 401K. However, you (actually your company) can only contribute 25% of your compensation, so just to reach the personal contribution maximum of $20,500 (like the average W2 employee or Solo 401K owner), you would have to make $82,000!

One advantage over the 401K is that your SEP Plan only needs to be established by the time your business files its taxes. Said another way, you can make your 2022 contributions in 2023 as, long as your Plan is created (and funded) by the Business tax-filing date (probably March 15 or April 15 of 2023). For 401Ks the Plan must be established by Dec. 31 of the year for which you would like to make contributions (see more below).

Solo 401K

The Solo 401K has similar maximum contributions of $61,000 for 2022 ($66,000 for 2023) but has two components: the elective deferral and the non-elective deferral. The elective portion is the amount the employee personally contributes, or $20,500 (like the average W2 employee), while the non-elective portion is the amount contributed by the employer (which is also you as an Independent Contractor). This is the balance to reach $61,000 (or $40,500). If the employee makes just $20,500, they can contribute that entire amount as the employee. There is no 25% of compensation stipulation for the employee contribution though contribution limits do apply for the employer contribution. However, if your business is just starting out and you have the wherewithal for a savings rate above 25%, the Solo 401K is a better option than the SEP. This is a great option if this is your side-hustle or maybe for a spouse starting a business for a family that’s not relying on income from the business.

In terms of flexibility, the Simple and SEP aren’t in the same ballpark as the Solo 401K. The Solo offers Spousal contributions, a Roth option, borrowing ability, catch up contributions or even Checkbook Control of your assets. So a spouse working in the business (a husband and wife team) can have his or her own contributions, basically doubling the savings a family can make – or if the spouse works more modest hours, he or she can again contribute up to $20,500 personally (assuming that person makes at least that much – potentially a 100% savings rate).

If taxes aren’t as much of a concern, a Solo 401K plan can be set up to have Roth Contributions, meaning taxes are paid once, then contributions are made, and assets grow tax-free and distributions are tax-exempt, even extending those benefits to heirs that inherit these Roth accounts depending on certain circumstances. (Editorial note: Simple and SEP participants will have a Roth option starting in 2023.)

Neither the SEP nor the Simple offer borrowing ability like a Solo 401K (prior to the CARES act, one could typically borrow up to $50,000 or 50% of his or her 401K), and while the Simple does offer a catch up contribution (but not the SEP), the Solo 401K catch up contribution of $6,500 in 2022 ($7,500 in 2023) is more than double that of the Simple (if you’re at least 50 years old). Lastly, the Solo 401K can be structured to give you Checkbook control of your assets, the ultimate in investing flexibility.

The downside (besides the calendar timing to establish discussed with the SEP) is that your 401K Plan must be established under specific Plan Documents. Most brokerages can do this, but if you want certain provisions (ie greatest flexibility), then you might need to pay a modest fee to a third-party. Additionally, once plan assets exceed $250,000 (a good problem, right?), Form 5500-EZ must be filed with the IRS annually.

So in closing, this is by no means an exhaustive list of the Retirement Plan savings vehicles available to Independent Contractors. Nor is it exhaustive in terms of the attributes of each of these three Plans, but I think it adequately states the case that the Solo 401K is the ideal Retirement Plan for those Independent Contractors looking to maximize long-term Retirement Savings potential, reduce their tax burden to the fullest extent and have flexibility – assuming these are of utmost importance.


Please check out more popular/related blog posts:

Why Should I Use a Financial Advisor for Asset Management?

How Do I Get Out of Credit Card Debt and Start a Budget?

How Can Effective Asset Management Help Me Reach Financial Independence?

How Much Should I Save for College?

Best (Most Read) MHB Advisory Blogs of 2019!


As well as other more recent posts:

Covid-19 Update (Part 1): What Moves Can Enhance Asset Management Now?

Covid-19 Update (Part 2): How Do I Manage/Find Cash in a Crisis?

What Should I Do with My Tax Refund?

Taxes and Fees: Why You Should Use a Financial Advisor for Asset Management

$1 Million Is Not Enough: How Much Do I Need to Save for Retirement

If you or someone you know has any financial-related questions, I would love to have a conversation, so please feel free to reach out: matt@mhb-advisory.com.

And stay tuned for additional blog posts on retirement savings and other topics.

Best wishes on your financial path!



This post was created by Matt Beeby, the Founder of MHB Advisory Services. Matt has been working in Financial Services and investing in real estate since 2005, though his investment experience spans nearly two decades. He is a Christ follower, active in both his church and his neighborhood association. Matt enjoys sports and family time. Read more about Matt on his website bio.


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