Retirement vehicles — the i401k, SEP and IRA, what’s the difference?
AI images of freelancers pondering tax-protected retirement vehicles. It's boring, but it will make you rich over time.
The ‘don’t blame me’ blurb: I am not a financial advisor, portfolio manager, or accountant. This is not tax or investment advice; it’s information to get you going. Please consult your trusty professional and do your due diligence. Carry-on!
Updated Jan 19, 2025
I know it’s all like some foreign language — welcome to alphabet soup city. You may have heard of these options, so I want to chat about them so you know the difference. Even your accountant might be a little out-of-date with what works best for freelancers and single-person businesses. The SEP was the hottest thing for freelancers, but not anymore.
Remember, these are the vehicles or wrappers our ETFs/funds sit inside, and we can put the same investments for a Three-Fund portfolio in all of them.
The i401k (aka Solo 401k)
This is for single-person businesses, freelancers, contractors, and your spouse. However, you cannot have any employees (except your spouse).
You can have the i401k contribution AND the IRA contribution every year.
The maximum contribution is the largest of the three: $23,500 ($31,000 if over 50 years old, $34,750 if age 60-63) in 2024 plus an additional up to 25% of your W-2 income. You can also have a $7,000 ($8,000 if over 50) IRA that you can roll into a backdoor Roth.
Example: You paid yourself $100,000 in W-2 salary. Your company can now contribute up to an extra $25,000 to your i401k. For those who are not an S-Corp using payroll, there is a formula that comes out to about 20%; read about it here.
Traditional (pre-tax): The money is not taxed as it goes in, so it’s a huge tax deduction. You are taxed on it when you start withdrawing it in retirement, but most likely at a much lower rate than in your prime earning years.
Roth is also allowable — you pay tax before the money goes in, but no tax when you use it in retirement.
You can open a deferred and a Roth i401k, but the limits below stay the same. You don’t get double! If you do have both, they must be with the same provider. You are not allowed to have multiple i401ks with different providers.
The maximum i401k contribution in 2025:
49 and under $70,000, 50+ $76,500
50+ $77,500
60-62 $81,250
SEP - Simplified Employee Pension
You can open a SEP and contribute to the tax year before, but you can’t do so with the i401k. Example: In February 2024, you can open a SEP and contribute to tax year 2023 if you do not have a retirement account setup. You can do this up until March 15 for S-Corps and April 15th, 2024 for self-employed. For those of you just finding out about investing for retirement, this can be a great move. In the year 2024, you could then establish and utilize an i401k retirement savings account.
You must use this one if you have even one W-2 employee who is not your spouse.
Contribution limits are potentially lower; your company can put in 25% of your income, but you don’t get the $23,500/$31,000 personal contribution, which you also get in an i401k above. Example: if you pay yourself $150,000/year, with a SEP, you can only contribute $37,500. The maximum in 2025 is $70,000
You can’t do a Roth version of a SEP.
With a SEP, you must give your employee(s) the same percentage of your contribution.
IRA - Individual Retirement Account (we will use it as a ‘Backdoor Roth IRA’.)
The IRA has a limit of $7,000 in 2025 and $8,000 if over 50 years old.
IRAs can be deductible if you do not have an i401k or other employer plan and you earn under $83,000. We all have an i401k (right?!) So, we will use the IRA to put after-tax money into the IRA and roll it into a Roth IRA. This is called a Back Door Roth IRA. Yes, it’s legal, although Congress looks like they might change it.
Example: Put $40,000 into your pre-tax i401k and $7,000 into the IRA. Then, roll the $7,000 into a Roth IRA. You do this online or by calling your provider (Schwab, Vanguard, etc.). This means you have two IRA accounts; an after-tax IRA and a Roth IRA. The after-tax IRA is used to deposit the money and then convert it in to the Roth IRA a few days later.
With a Roth IRA, just like a Roth i401k, you do not pay tax when you start withdrawing money in retirement.
Some SEP plans will also allow an IRA through a loophole, but it depends on the plan.
If you already have money in another IRA, please check with your accountant or advisor. Having money in an IRA can affect the above Back Door Roth strategy, a gotcha called the ‘Pro-Rata Rule.’
The Exciting Conclusion?
Go with the i401k if you don’t have employees besides your spouse, and open an IRA and Roth IRA if you have excess cash. Chat with your accountant or financial advisor about it. Just be aware some accountants are not up to date on what an i401k is according to what visitors of this website have told me.
Some accountants are still advising using a SEP. If that happens get them to look under the hood of the i401k and they’ll get it.