How I Max Out My Retirement Account as a Freelancer

Written by Rebecca Lake

Financial Expert

Edited by Kristin Marino

Managing Editor

Self-employment offers plenty of perks, but there’s one thing you don’t get when you work for yourself. There’s no employer-sponsored retirement plan waiting in the wings to help you save and invest for the future.

You’re not without options, however. There are retirement accounts designed for freelancers, independent contractors, and small business owners in mind.

A SEP IRA allows you to stash away thousands of dollars in income each year and enjoy some tax advantages while you’re at it. As a full-time freelancer, I’ve been using a SEP IRA to grow my retirement nest egg since 2014.

I’ll walk you through how a SEP IRA works, who can open one, and how to max out your account each year.

What Is a SEP IRA?

A SEP IRA, or simplified employee pension individual retirement account, is a special type of retirement account designed for businesses of any size. You can open a SEP IRA whether you’re self-employed and run your business solo or have a growing small business with employees.

SEP IRAs work like traditional IRAs but are for business owners. If you’re unfamiliar with a traditional IRA, it’s an individual retirement account you can contribute money to each year. Here are some of the main points to know about SEP IRAs:

• The money you contribute grows tax-deferred.
• Annual contributions are tax-deductible.
• Withdrawals are taxed as ordinary income.
• Early withdrawals may be subject to taxes and penalties.

Again, those are all features of a traditional IRA, but there’s one big difference. SEP IRAs offer much higher annual contribution limits than traditional IRAs.

Why I Chose a SEP IRA for Retirement Savings

A SEP IRA is one of several retirement savings options if you’re self-employed or freelancing. You could also set up a traditional IRA, Roth IRA, SIMPLE IRA, or a solo 401(k) plan.

Traditional and Roth IRAs are available to anyone — you don’t have to be self-employed to open them. A SIMPLE IRA is a retirement plan for self-employed people and businesses with less than 100 employees. Solo 401(k) plans work like employer-sponsored plans in most ways, but you don’t get a company match, and you can only open one if you’re a sole proprietor or your only employee is your spouse.

Each offers a tax-advantaged way to save, but a SEP IRA made the most sense for me. Here’s why.

• SEP IRAs offer higher annual contribution limits for self-employed individuals compared to traditional, Roth, or SIMPLE IRAs.
• Opening a SEP IRA through my brokerage was much easier than setting up an individual 401(k).
• I pay fewer fees to maintain my SEP IRA than I would with a solo 401(k).

Now, are there some downsides to using a SEP IRA to save for retirement as a freelancer? It depends on how you look at it.

SEP IRAs don’t allow catch-up contributions like other plans once you turn 50. For instance, a solo 401(k) doesn’t have that obstacle. But if you’re not able to fully max out your plan each year, you may not be too concerned about missing out on catch-up contributions.

Aside from that, SEP IRAs don’t allow loans like a 401(k) would, either. That’s a downside if you need to withdraw cash early since you’ll likely get hit with taxes and penalties. But no access to loans makes it less tempting to pull money out of your retirement account unnecessarily.

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How Much Can You Contribute to a SEP IRA?

The IRS decides how much you can save in a SEP IRA. The annual contribution limits are routinely updated to account for inflation. For the 2024 tax year, savers can contribute the lesser of:

• Up to 25% of your total compensation, OR
• $69,000

For 2024, the maximum compensation limit you can base the 25% calculation on is $345,000.

If you’re self-employed, different rules apply. Generally, your contributions are limited to 20% of your net income. Net income means your net profit on Schedule C that’s reduced by deductible self-employment tax.

That means that I usually don’t max out the total annual contribution limit each year. For example, in the 2023 tax year, I was allowed to contribute $53,000 even though the maximum limit was $66,000.

Compared to the $6,500 limit for a traditional or Roth IRA, however, I came out ahead with the contributions I was able to make.

Pros and Cons of SEP IRAs

SEP IRAs offer a simple and flexible retirement savings option with high contribution limits and tax advantages.

However, they have some restrictions, such as no employee contributions and early withdrawal penalties.

Understanding the pros and cons can help you decide if a SEP IRA is right for you.

How I Max Out My SEP IRA Each Year

Figuring out how much you can contribute when you’re self-employed can get tricky since you may not know your net profit until the end of the year. Having an income that fluctuates month to month can also add a wrinkle.

Here’s how I decide what to contribute and when to make those contributions.

Step 1: Review the Previous Year

Looking at your past year’s income is a good way to estimate what you can contribute to a SEP IRA if you’re just getting started with one.

You can use an online SEP IRA calculator to get an idea of how much of your income you can save if you’re self-employed.

Here’s a tip: If your income grows yearly, you might use your lowest-earning year as a baseline for calculating SEP IRA contributions.

Why? The IRS requires you to correct excess contributions to a SEP IRA, meaning that if you put in more money than you’re allowed, you’ll have to take it back out. If you don’t do so, the IRS can hit you with a tax penalty until you make the correction.

Step 2: Break It Down Monthly

If you have an idea of what you can contribute to a SEP IRA for the year, the next step is to figure out when to make your contributions.

You could fund your SEP all at once, either at the beginning or the end of the year. I prefer to make monthly contributions instead.

Each January, I look at the estimated amount I should be able to contribute based on my prior year’s income and divide it by 12. Then, I transfer that amount each month from my checking account to my SEP IRA.

This ensures that my money is benefiting from compounding interest throughout the year. Compounding lets you earn interest on your interest. The sooner you make contributions, the sooner your money can start to grow.

Step 3: “Catch Up” Before the Deadline

Here’s one essential thing to know about SEP IRAs. You have until the April tax filing deadline to make contributions for the previous year. So, if you opened a SEP IRA on January 1st, 2024, you’d have until the April 2025 filing deadline to make contributions for the 2024 tax year.

It’s a little confusing, but once you get used to the timing, you realize what an advantage it is. If you’ve underfunded your SEP throughout the year, you’ll have a small window before the tax deadline to make up for that with additional contributions.

That’s a strategy I’ve used year after year to make sure I get every penny I can into my SEP IRA.

So, how do I know what to save? I use tax filing software for self-employed people that tells me how much more I can contribute for the year based on my income, deductions, and credits. Once I’ve done my taxes, I contribute that amount in a lump sum before the April tax deadline.

It’s my version of a catch-up contribution, and it’s a simple but effective way to ensure I’m maxing out my plan contributions and the amount I can deduct.

How to Set Up a SEP IRA

If you’re interested in opening an SEP IRA, it’s easy to do so through an online brokerage. Vanguard is the one that I use, but you can find other brokerages that offer SEP IRAs for self-employed individuals and small business owners.

You’ll need to fill out an application and link a bank account, so you make contributions. When comparing SEP IRA options at different brokerages, be sure to consider:

• Minimum opening deposit requirements, if any
• Investment options
• Minimum investment thresholds for individual mutual funds or index funds
• Fees
• Online and mobile account access
• Customer service
• Overall reputation

Even if you’re not able to max out a SEP IRA just yet, opening one could still be worth it if you’re actively trying to grow your business or self-employment income.

Remember that time is on your side when it comes to compounding interest, so saving even a little bit each month can help you get a jump on retirement planning.

Comparing a SEP IRA to other retirement plans for self-employment can help you decide which one makes the most sense for you.