What retirement account should a self-employed person use?

Self-employed people have access to retirement accounts with contribution limits far above a standard IRA, and most do not use them. A solo 401(k), available to a business with no employees other than a spouse, permits contributions in two capacities: as the employee, an elective deferral up to the standard 401(k) limit, and as the employer, an additional profit-sharing contribution based on a percentage of compensation. Combining both typically produces the highest total contribution available at moderate income levels, and many providers offer a Roth option for the employee portion.

A SEP IRA is simpler administratively and allows employer contributions up to a percentage of net self-employment earnings, subject to an annual cap. It has no employee deferral component, which is why it usually permits less than a solo 401(k) at lower and middle incomes and catches up at higher ones. It can be opened and funded up to the tax filing deadline including extensions, which makes it useful for someone who realizes in March that they want a deduction for the prior year. The significant limitation is that if you have eligible employees, you must contribute the same percentage of compensation for them as for yourself.

A SIMPLE IRA suits businesses with employees, allowing employee deferrals with a required employer match or contribution, at lower limits than a 401(k) but with far less administrative burden. Two practical points that apply across all of them. Contribution calculations for the self-employed are based on net earnings after the deduction for half of self-employment tax, so the effective percentage is lower than the headline figure and the arithmetic is genuinely easy to get wrong. And deadlines differ: a solo 401(k) generally must be established by the end of the business's tax year for employee deferrals, while employer contributions and SEP IRAs allow more time, which means acting in December rather than April preserves more options.