Do You Need A Tax Shelter?

Let’s say that you fit into one of these unconventional preretirement profiles:

  1. You’ve retired from your long-term career but are free-lancing as a consultant for a few years
  2. You still are working, but you’ve taken free-lance jobs to boost your retirement capital
  3. Your employer has downsized, and now are working for it as an independent contractor
  4. After retiring you’ve started your own business in a new field

In each of these cases, you have self-employment income that could be eligible for additional tax shelter – even if you are covered by an employer’s regular retirement plan.  You have the opportunity to build much more retirement capital on a tax-deferred basis.


A Simplified Employee Pension (SEP) operates very much like a regular IRA:

  • Contributions are tax deductible, and you pay no tax on your investment earnings until they are withdrawn.
  • You may make withdrawals (but not receive loans) at any time.  Withdrawals are taxed as ordinary income tax rates of up to 35%.
  • Withdrawals prior to age 59 ½ incur a 10% penalty in addition to the tax that you would owe.
  • You can roll over the proceeds from a SEP to an IRA for continued tax deferral.
  • A schedule of annual withdrawals from the account must begin by April 1 of the year following the year that you reach age 70 ½.

With a SEP you can contribute and deduct up to 20% of your self-employment income up to a maximum of $49,000, adjusted annually for inflation, or 25% of your compensation income if you have incorporated.  The maximum compensation that you can consider when figuring SEP contributions and the deduction for contributions is $245,000.  

The Solo 401(k)

The Solo 401(k) is available to self-employed individuals and, generally, business owners who have no other full-time employees (except a spouse).

There are two components to your 401(k) contributions, which is what differentiates the plan from a SEP.  You may defer up to 100% of the first $16,500 of your self-employment income every year ($22,000 of age 50 or older) – the same amount that can be contributed to a traditional 401(k) plan. 

On top of that, you can contribute and deduct an additional amount of up to 20% of your self-employment income or 25% of your W2 compensation income (the profit sharing portion of your contribution).  In total, you can contribute up to $49,000 to a Solo 401(k).  You can double the amount if your spouse works with you.  Contributions are completely discretionary:  They may rise and fall, or even be skipped in any year, depending upon how your self-employment income is doing.

If you are covered by an employer’s qualified retirement plan, your contributions to plans based upon your self-employment income will be limited by that fact – consult with your tax advisors to learn more.

With the increased questionability on Social Security, are you putting more emphasis on your own retirement strategies?  If you are a business owner what tools are you using?


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