Given that the contribution limits are the same for either account, should you set up a SEP IRA or a Solo-401k for your locums or side hustle income? Formerly, the main reason to choose a SEP IRA over a Solo-k was that you could set up and contribute to a SEP IRA after the close of the year. In fact, if you file an extension for your tax return, you have until the extended due date to establish and contribute to your SEP IRA for the prior year (September 15 for partnerships and October 15 for individuals and corporations). This is no longer the case, as you now have until the due date of your tax return, including extensions, to set up a 401k, too, unless you are making an employee deferral ($20,500 for 2022). If so (typically true for full-time 1099 doctors instead of those with a side hustle in addition to their W2 “day job”), the due date for setting up your 401k remains 12/31/xx.
One disadvantage of having a SEP IRA is the “pro-rata” rule. If you have a balance in any pre-tax IRA accounts on the last day of the year when you complete a back-door Roth IRA contribution, you will owe tax on the conversion. “IRA” accounts include Traditional IRAs (TIRAs), SIMPLE IRAs, and SEP IRAs.
Other disadvantages of using a SEP IRA include:
- No catchup contribution available for those age 50+ (an additional $6,500 for a 401k in 2022)
- No employee deferral, which can be particularly important when you are launching your 1099 work or working part time and not making enough to max out at $61k (2022), based on 20% of [net profits – (1/2 related FICA taxes)]
- No Roth contributions allowed for a SEP IRA while a 401k allows you to set up a plan allowing employee Roth deferrals and “Megabackdoor Roth” contributions
- No safe harbor contribution limitation (3%) if you have other employees (for a traditional 401k). This means you must contribute the same match for qualifying employees as you do for yourself, up to 25% of pay.
In general, we recommend a solo-k over a SEP in most every situation, but there have been times in which a client needs to start with a SEP and then roll into a new Solo-k. As always, discuss the particulars or your situation with your CPA or EA.