If you are a self-employed solopreneur physical therapist or occupational therapist, you are both the owner of your business and an employee of your business.
While fulfilling both employer and employee roles, you probably have a lot on your plate and not much time to figure out which retirement account will better suit your needs.
This article will help you do just that by comparing and contrasting two retirement accounts that self-employed solopreneurs commonly use:
The Individual 401(k) vs The SEP IRA
Before diving in, be sure to first get a grasp on the basics of what each of these types of retirement accounts has to offer. You can do this by clicking on the name of each retirement account above.
Once you’ve got a good foundational understanding of both retirement accounts, you will be ready to figure out which one best suits your needs.
We will do this together by comparing
- The Amount You Can Contribute
- The Option For Catch-Up Contributions
- The Option For Roth Contributions
- The Option To Take Out A Loan
- The Impact Of Having Employees (other than yourself)
- The Deadline For Opening An Account & Making Contributions
Let’s get started.
1. Contribution Amounts
The amount that can be contributed to a SEP IRA is different from the amount that can be contributed to an individual 401(k).
Only an employer contribution can be made to a SEP IRA and this must be made by your business rather than by you personally.
In year 2022, an employer contribution of 25% (or an estimated 20% if you are operating as a sole proprietor, but have your tax professional calculate the percentage for you) of your income can be made to your SEP IRA.
Both an employer contribution and an employee contribution can be made to an individual 401(k). The employer contribution is made by your business and the employee contribution is made by you.
Just like a SEP IRA, in year 2022, an employer contribution of 25% (or an estimated 20% if you are operating as a sole proprietor, but have your tax professional calculate the exact percentage for you) of your income can be made to your individual 401(k).
In addition, you can contribute an employee contribution of the lesser of $20,500 or 100% of your employee compensation to your individual 401(k).
Example To Better Compare:
Let’s say Jane is a physical therapist who is a solopreneur home health clinician who contracts with home health agencies while operating as an LLC. She made $100,000 this year (year 2022), so she can receive an employer contribution of up to 25% of that $100,00 to either a SEP IRA or an individual 401(k). That is an employer contribution of $25,000.
However, recall that an individual 401(k) also allows for an employee contribution of up to $20,500 or 100% of her compensation, whichever is less – in this case the $20,500 is the lesser of the two. Therefore, with an individual 401(k) she can make an employee contribution of $20,500. Unfortunately, a SEP IRA does not allow for any employee contribution.
What’s the difference?
That’s a big difference in total contribution.
Because an individual 401(k) also allows an employee contribution, you can more easily contribute the maximum allowable amount towards your retirement.
Because only an employee contribution can fund your SEP IRA, you will need a greater income to contribute the maximum allowable amount.
2. Catch-Up Contributions
Catch-up contributions are the opportunity to put more money into a retirement account if you are older than a certain age determined by the IRS.
According to the IRS, you are not allowed to make any catch-up contributions to a SEP IRA.
You are allowed to contribute up to an extra $6,500 (for year 2022) to your individual 401(k) if you are older than 50 years of age.
This catch-up contribution is considered part of the employee contribution, but in addition to the already allowed $20,500 for year 2022.
Example To Better Compare:
Let’s use the example of Jane the physical therapist covered earlier, except we’ll reveal that Jane is 52 years old.
That means her age qualifies her to a make catch-up contribution to her individual 401(k):
An individual 401(k) allows physical therapists and occupational therapists older than 50 years of age the opportunity to contribute additional money for retirement – a SEP IRA does not.
3. Roth Option
The ability to make pre-tax contributions to a retirement account is commonly referred to as a “Roth Option.”
According to the IRS, pre-tax contributions cannot be made to a SEP IRA – only tax-deferred contributions can be made.
All employer contributions to an individual 401(k) must be made on a pre-tax basis.
However, employee contributions can be made as either pre-tax or tax-deferred.
Therefore, an individual 401(k) allows for pre-tax and/or tax-deferred contributions.
An individual 401(k) allows the Roth option, allowing you the opportunity to diversity how your retirement contributions will be taxed.
A SEP IRA does not.
4. Loan Option
With some retirement accounts, you have the option to take out a loan on your account balance.
According to the IRS, you cannot take out a loan on a SEP IRA.
It is possible to have the option of taking out a loan on your individual 401(k) balance, but it depends on if the brokerage your 401(k) is with will let you.
You can read more about which brokerages provide a loan option here.
An individual 401(k) can provide you with the opportunity to take out a loan against your account balance, while a SEP IRA does not.
5. Having Employees
By definition, a solopreneur like yourself doesn’t have employees. But what if you choose to expand your business in the future by hiring some?
Some retirement accounts are designed to accommodate such a change, others are not.
You can open and/or continue to contribute to a SEP IRA even if you hire employees.
However, each employee must also be given a SEP IRA if they fulfill all of the following:
- Are at least 21 years old
- Earn more than $600 annually
- Have worked in your business 3 out of the last 5 years
Your business must also contribute the same percentage of income to each employee’s SEP IRA – and that includes your own SEP IRA as well since you are an employee of your own business.
For example, let’s say Jack is your employee who made $10,000, Jill is also your employee who made $20,000, and you, as an employee of your own business, made $100,000. You decide to have your business contribute 10% of each employee’s income to each respective SEP IRA.
So your business will need to contribute $1,000 to Jack’s SEP IRA, $2,000 to Jill’s SEP IRA, and $10,000 to your SEP IRA.
This illustrates how SEP IRA contributions made by the business must all be of the same percentage. You can’t contribute a different percentage to any single employee, not even a larger percentage to yourself.
To be eligible to open an individual 401(k), you cannot have any full-time employees.
Full-time is defined as working more than 1,000 hours in a given year or working at least 500 hours per year for 3 years in a row.
The one exception to this rule is that your spouse may work as your employee even in a “full-time” capacity.
If you already have an individual 401(k) and your business hires an employee that is not your spouse, then you can’t continue to contribute to your individual 401(k). You can either keep your individual 401(k) and allow the investments in it to grow or you can open IRAs for you and your new employee and then roll your individual 401(k) over into that new IRA.
6. Deadline For Opening An Account & Making Contributions
Some retirement accounts give you more time to make contributions than others.
You can open a SEP IRA and your business can contribute to it up until you pay your taxes.
If you pay your taxes on April 15th of the following year, that gives you time to assess where you stand financially at the end of this year before a contribution is made.
If you need more time and end up filing an extension for paying your taxes, you can wait even longer to open and have your business contribute to your SEP IRA as taxes filed with an extension are often paid on October 15th.
Remember that both an employer and an employee contribution can be made to an individual 401(k).
Similar to the employer contribution with the SEP IRA, the employer contribution can be made to your individual 401(k) up until the date you pay your taxes. This is often April 15th of the following year or, if you file an extension, October 15th.
However, you don’t get quite as long to make the employee contribution as it must be made by the current year’s end.
If you don’t already have an individual 401(k), you must also open the account before the current year’s end.
There’s a lot to consider, so here’s a table to summarize more succinctly:
If you are a self-employed solopreneur with a goal of contributing as much as you can to your retirement account, the individual 401(k) may suit you better than the SEP IRA.
However, if this current year passes by and you find yourself wanting to open a retirement account before filing your taxes, then an individual 401(k) will no longer be an option and you will end up needing to go with SEP IRA unless you chose to wait for the following tax year.
Are you are solopreneur physical therapist or occupational therapist? Which retirement account best suits you? Let me know in the comments section below!