You can contribute to a 401(k), a retirement savings plan offered by employers, and also contribute to a SEP IRA, a retirement savings plan for self-employed individuals. The contribution limits for each plan are different, so you should consider your financial goals and income when deciding how much to contribute to each plan. You can contribute to both a 401(k) and a SEP IRA in the same year, but the total amount you can contribute to both plans is limited.
Workplace Retirement Plans
Workplace retirement plans, such as 401(k)s and SEPs, offer tax advantages to encourage individuals to save for retirement. While both plans provide similar benefits, there are key differences to consider when determining which plan is most suitable for your needs.
- 401(k) Plans:
- Employer-sponsored retirement plans that allow employees to contribute pre-tax dollars from their paycheck.
- Employer may make matching contributions.
- Withdrawals generally subject to income tax and may also be subject to early withdrawal penalties.
- SEP IRAs:
- Retirement accounts established by self-employed individuals or small business owners.
- Employer (business owner) makes contributions on behalf of eligible employees, including themselves.
- Contributions are tax-deductible to the business.
- Withdrawals subject to income tax.
Contribution Limits:
| Plan Type | Employee Contribution Limit (2023) | Employer Contribution Limit (2023) |
|---|---|---|
| 401(k) | $22,500 ($30,000 if age 50 or older) | Up to 100% of compensation, max $66,000 ($73,500 if age 50 or older) |
| SEP IRA | Not applicable | Up to 25% of net self-employment income, max $66,000 ($73,500 if age 50 or older) |
It’s generally not possible to contribute to both a 401(k) and a SEP IRA in the same year. However, individuals who are eligible for both plans may contribute to one and take advantage of the higher contribution limits of the other through a process known as a “sidecar account.” Consult with a financial professional for specific guidance on your eligibility and contribution options.
Self-Employed Retirement Options
Self-employment offers flexibility and autonomy, but it also comes with the responsibility of managing your retirement savings. As a self-employed individual, you have several retirement options to choose from:
401(k) Plan
A 401(k) plan is a tax-advantaged retirement savings account offered by employers. As a self-employed individual, you can establish a 401(k) plan for yourself, known as a Solo 401(k) or individual 401(k).
- Contribution Limits: For 2023, the contribution limit is $22,500 (plus a $7,500 catch-up contribution for individuals age 50 or older).
- Employer Matching: As the employer, you can make matching contributions up to 25% of your compensation.
- Tax Benefits: Contributions are made pre-tax, reducing your current taxable income. Earnings grow tax-deferred until withdrawn in retirement.
SEP IRA
A SEP IRA (Simplified Employee Pension Individual Retirement Account) is a simplified retirement savings plan for self-employed individuals and small business owners.
- Contribution Limits: The employer must contribute equally for all eligible employees. For 2023, the maximum contribution limit is the lesser of 25% of compensation or $66,000 (plus a $7,500 catch-up contribution for individuals age 50 or older).
- Employer Matching: Not required.
- Tax Benefits: Contributions are made pre-tax, reducing your current taxable income. Earnings grow tax-deferred until withdrawn in retirement.
Comparison of 401(k) and SEP IRA
| 401(k) | SEP IRA | |
|---|---|---|
| Contribution Limits | Employee: $22,500 ($7,500 catch-up) | Employer: Lesser of 25% of compensation or $66,000 ($7,500 catch-up) |
| Employer Matching | Optional | Not required |
| Tax Benefits | Pre-tax contributions, tax-deferred earnings | Pre-tax contributions, tax-deferred earnings |
| Contribution Method | Payroll deductions | Employer contribution |
Contribution Limits
Both 401(k)s and SEP IRAs have annual contribution limits set by the IRS. For 2023, the limits are as follows:
- 401(k): $22,500 ($30,000 for those age 50 or older)
- SEP IRA: $66,000 ($78,000 for those age 50 or older)
The SEP IRA contribution limit is higher than that of the 401(k). However, for 401(k)s, employers can also make contributions on behalf of their employees, which can reduce the employee’s taxable income.
Eligibility
The eligibility requirements for 401(k)s and SEP IRAs are different:
- 401(k): Available to employees of businesses that establish 401(k) plans. Eligibility requirements typically include age (usually 21) and minimum hours worked or a specific length of employment.
- SEP IRA: Available to self-employed individuals and their employees (if any). Business owners must establish a SEP IRA plan for themselves and all eligible employees.
Self-employed individuals who meet the eligibility requirements for both a 401(k) and a SEP IRA can contribute to both accounts in the same year.
Contributing to Both a 401(k) and SEP IRA
Many individuals opt to contribute to both a 401(k) and a SEP IRA to maximize their retirement savings. However, it’s important to understand the tax implications and benefits associated with each option.
Tax Implications
- 401(k): Employee contributions are pre-tax, reducing current taxable income. Employer matching contributions are also tax-deferred.
- SEP IRA: Contributions are made on a pre-tax basis, reducing current taxable income.
Contribution Limits
| Plan Type | 2023 Contribution Limit |
|---|---|
| 401(k) | $22,500 ($30,000 for those age 50 and older) |
| SEP IRA | 25% of self-employment net income, up to $66,000 ($73,500 for those age 50 and older) |
Benefits
- Tax-deferred growth: Investments grow tax-free until withdrawn in retirement, potentially significantly increasing earnings.
- Increased retirement savings: Contributing to both a 401(k) and SEP IRA allows for a higher overall savings rate.
- Diversification of retirement assets: Each plan offers different investment options, allowing for a more diversified portfolio.
Note: Early withdrawals from either plan may be subject to income tax and penalties.
Well, there you have it, folks! Now you know the ins and outs of contributing to both a 401(k) and a SEP IRA. Remember, saving for retirement is crucial, and these plans offer flexible ways to do it. So, whether you’re just starting out or nearing retirement, consider exploring these options to secure your financial future. Thanks for reading, and don’t forget to swing by again later for more money-savvy tips and tricks!