On Your Own?


For many looking to cast off the corporate shackles and live in the freelance eat-what-you-kill, work-in-your-PJs wilds of the gig economy, there is one very large incentive keeping them in the 9-to-5. No, it’s not the endless supply of free birthday cakes that seem to pop up weekly in your typical office — although freelancers do miss them from time to time. It’s the chance to invest in your future.

Stay in the machine, toil among the cogs, and you can at least count on your employer to offer you a 401K. Your company might even match your contributions — the opportunity to get money for literally nothing definitely makes one take a long look at their cubicle before tendering that resignation letter and setting out a shingle.

But don’t joylessly plop yourself back down in that task chair just yet — there is a way to enjoy the unfettered lifestyle of the self-employed while socking away money tax-free.

It’s called a SEP IRA, or Simplified Employee Pension Individual Retirement Account. Much like a traditional IRA, a SEP IRA lets you make tax-deductible contributions to an investment account while deferring taxes until you reach retirement age, at which point distributions are taxed as income.

As you’d imagine, when the IRS gets involved there are mountains of fine print, but it’s in those caveats we find a product perfect for small businesses and the self-employed.

“For those who are self-employed, A SEP IRA allows them to contribute a larger percentage of their salary. In 2019, they’re allowed to contribute $56,000 or 25 percent of their compensation, whichever is less. If they go to a regular IRA, they have a $6,000 cap, or $7,000 if they’re over 50, on what they can contribute in an IRA,” said Eric Magnin of Boys, Arnold & Co., a financial planning and wealth management firm. “What’s good is they’re portable. You can move them … to another IRA; if you have another IRA you can drop it into the SEP so it’s all managed in one spot.”

In addition to giving you the ability to sock away more money than a traditional IRA, a SEP IRA is extremely friendly to the feast-or-famine income cycle of the self-employed. Magnin notes that there are no penalties if you don’t contribute during one of the “famine” cycles. And since a sole practitioner is usually serving as CEO, IT administrator, office manager, marketing department and janitor, a SEP IRA’s ease of use is a huge advantage.

“There’s no administration, so there’s no filing with the IRS like you have with other plans,” said Bill Brady with Crossroads Financial Group.

So a SEP IRA allows the self-employed entrepreneur to contribute more to their account than a traditional IRA, gives them an escape plan if corporate America comes calling again and it’s easy to use. What’s the downside? For one, no catch-up contributions if you’re over 50. For another, there’s no Roth IRA equivalent to a SEP IRA, meaning you can't elect to pay taxes on contributions now in order to take distributions tax-free in retirement.

“Because it is a variation of an IRA, that money is always liquid, but if you pull it out before age 59.5, there’s a 10 percent penalty and you have to pay taxes on it,” Brady said. “To complicate things maybe another step, when you hit age 70.5, at that point the government tells you that you have to start taking money out of it.”

Another possible sticking point for those eyeing a SEP IRA comes when that sole proprietor becomes a small business. “It becomes a bit of a challenge if you have employees,” Brady said. “They have to be placed on the plan as well if they’re eligible.”

Thankfully, there are conditions on what constitutes an “employee” to the IRS. They must be 21 or older, have worked for the company for three to five years and have received compensation of at least $600.

“It gets a little iffy, but the distinction is, ‘Are you employed by yourself?’ If you are, good, then you can have a SEP IRA rather than a traditional. If you have employees, you have to look at how many of those employees you have to cover,” Brady said.

Ultimately, a SEP IRA is designed for the modern workforce of the self-employed.

“There are other plans,” said Brady. But if you’re self-employed and want to sock some money away, it’s the way to go.”

Added Magnin, “My thinking is anytime you can save for retirement and defer taxes, that’s a win-win.”

Ready to set one up yourself? Search irs.gov for IRS Form 5305-SEP.


Beyond a Simplified Employee Pension Individual Retirement Account, there are a few options for small businesses to pursue as they attempt to court the best talent with sweet investment plans.

A SIMPLE (Savings Incentive Match for Employees) IRA is designed for companies of 100 employees or less. As easy to set up as its name suggests, it caps contributions at $13,000 a year for employees under 50 and $16,000 a year for employees over 50.

A traditional 401K allows employees to contribute up to $18,000 a year, as long as the employer contributes as well. They’re much harder to set up, but they help lower your tax burden and are good for businesses of more than 100 employees with payroll north of $500,000.