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How To Save More Than $100,000 A Year Pre-Tax: Open A SEP-IRA Or Solo 401k

Updated: 12/10/2021 by Financial Samurai 145 Comments

How to save a lot of money in your pre-tax 401k or SEP IRA

One big goal on Financial Samurai is to highlight to readers what is financially possible. Once you know what is possible, you minimize your limiting beliefs and tend to strive much farther. You can actually save more than $100,000 in your pre-tax retirement accounts per year! Let me explain with some basics first.

The 401k maximum contribution for 2021 is $19,500 and $20,500 for 2022. The increases will likely continue by $500 increments every year or two to keep up with inflation. Contributing the maximum pre-tax a year for 30+ years will most likely make you a 401k millionaire by the time you retire.

Unfortunately, $3 million is the new $1 million, and in 30 years, $7 million will likely be the new $1 million if we assume a 3% annual inflation rate!

The 401k is not enough for most people to retire on. Sure, we potentially have Social Security to help us when we reach, at the earliest, 62 years of age. But I wouldn’t count on the government to properly manage our money until then. Beyond maxing out a 401k every year, I encourage everyone to also invest at least 20% of their after-tax, after-401k money into a diversified investment portfolio.

As a contractor over the past year, I’ve discovered something that will really supercharge one’s pre-tax retirement savings. The discovery still seems too good to be true, but it is true. The research I’ve done is based off the IRS website, my own experience, and speaking to Fidelity’s small business retirement department where I have a rollover IRA, SEP-IRA, and Solo 401k.

How To Save Big In Your Pre-Tax Retirement Savings Plans

Let’s say you’ve got a cushy job paying $212,000 a year. You contribute $19,500 to your 401k and get a nice 4% match.

Furthermore, you can’t contribute to a traditional IRA because you make too much. Therefore, what is a retirement super saver supposed to do if s/he wants to save more than $19,500?

Answers:

1) Find a better employer who will contribute more to your pre-tax retirement savings account(s). $57,000 max 401k contribution for 2021 (employer profit sharing + $19,500 by employee)

or

2) Be an employee and a contractor/business owner! Max is $114,000.

The first thing I did when I left my old job of 11 years was roll over my 401k into an IRA. There are many benefits to a rollover IRA, including more investment options and lower costs.

The only issue with my rollover IRA is that I can no longer contribute pre-tax to the investment account. Its growth mainly comes from asset and dividend growth. I don’t bother contributing $5,500 in after-tax money because of the two other retirement accounts I get to contribute pre-tax.

As an employee of an online media company, I get to participate in the company’s SEP-IRA plan. Any self-employed individual or business owner with or without employees can open up a SEP-IRA. The funds are completely funded by the employer.

The employer can contribute up to 25% of compensation, up to a maximum of $57,000 in 2021. Doing simple math to discover how much income you need in order to save $57,000 using a 25% contribution rate = $57,000 / 25% = $228,000. IRS link on SEP.

Making $228,000 is not exactly a piece of cake as an employee. You’ve probably got to pay your dues over many years to get to such a level or more, but it’s possible.

If you do manage to make $228,000 in income, you’ve still got to pay Federal tax, State tax (if you are not living in a no income tax state), and FICA tax (6.2% Social Security + 1.45%) on that income. After you make $228,000 or more, you’ve got to then convince your employer to contribute 25% of your income to your SEP-IRA.

As an independent contractor, I’ve opened a Solo 401k (aka KEOGH 401k, Self-Employed 401k, One-Participant 401k), which is meant for a business owner with no employees.

My duties as an employee for an online media business is different from my contracting business. The online business makes money mainly through advertisement. My contracting business makes money by me consulting with other companies mainly on their content marketing initiatives.

The Solo 401K has the same contribution limits of up to 25% of compensation, to a maximum of $57,000. So in other words, I can try and make $228,000 as an independent contractor to contribute $57,000 pre-tax in my Solo 401k as well.

The grand result is that a ~$440,000 combined income can ultimately save a total $114,000 in retirement accounts tax deferred. The combined adjusted gross income (AGI) is therefore $440,000 – $114,000 = $326,000, which is taxed at a 35% marginal Federal tax bracket.

I originally thought the total pre-tax retirement contribution was $57,000 across all accounts. But when I called the Fidelity retirement department for small businesses, they verified with me that I can indeed contribute $114,000 total if I have two separate accounts as an employee (with no ownership) and independent contractor.

The idea is to open a SEP-IRA as an independent contractor/business owner if your employer has a 401k program, and vice versa. If you open up a solo 401k while already contributing to an employer 401k, then the max you can contribute is $57,000 combined.

The Ideal Retirement Income / Savings Scenario

Given there is a progressive tax system in America (see chart), making $500,000 a year in combined income might not be the best move to avoid the marriage tax penalty, which has almost all but gone away after Trump’s 2018 Tax Reform plan.

2020 Federal Income Tax Brackets

If you decide that you want to make $500,000 a year in income to contribute ~$120,000 in pre-tax retirement money, then you must make $500,000 as an employee and as a contractor/business owner.

Remember, there’s only one type of main retirement account per business entity, and that one retirement account limit is $57,000 a year or 25% of income, whichever is less. In other words, if you make $425,000 in your business alone, you can’t contribute $425,000 X 25% = $108,000. You can only contribute $54,000 to your SEP.

The solution is to therefore try and earn as close as possible to $220,000 in income as an employee for the SEP-IRA, and another $212,000 as an independent contractor for your Solo 401k.

Pay Attention To Government Policies

Remember, the government sets these pre-tax contribution rules, not you or I. President Obama made it clear when he was debating Mitt Romney that any individual or married couple making over $200,000/$250,000 is considered rich, and will be targeted for increased taxes and deduction/credit phaseouts. The compromise in the House was made for increasing taxes on income over $413,200 a year.

Now, Joe Bide says he plans to raise taxes on anybody making over $400,000 a year. That’s much more reasonable than the $200,000/$250,000, especially due to inflation and residents in higher cost of living areas.

SEP-IRA and Solo 401k Combo Retirement Savings Potential Chart

The above chart highlights five different scenarios that encapsulates most people. The first two scenarios in blue are for people who are employees only. Most people don’t take full advantage of their pre-tax retirement contributions (scenario 1), but some people do (scenario 2) and will really accumulate a health financial nut over time.

The three other scenarios in red are employee plus contractor scenarios, which enables one to save way beyond the typical amounts due to the opening of a SEP-IRA or Solo 401k as a contractor, whichever your employer doesn’t have.

Here are the five hurdles one must overcome to get into scenarios 3-5:

1) Your employer might not agree to let you start your own business or work as an independent contractor. The solution is to join a company that provides you the flexibility to consult after hours. Maybe you become an employee of a relative, a good friend, or simply a progressive company that allows for greater freedom.

2) Your employer might not value you enough to pay you $212,000+ in salary.

3) Even if your employer pays you a $212,000+ salary, they might not be willing to then provide profit sharing up to the maximum limit a year via a SEP-IRA or 401k plan. It is more common for larger corporations to offer 401ks over SEP-IRAs because once a business says they will contribute X % to an employee’s SEP-IRA, they have to contribute X % to all employee’s SEP-IRA. You can see how the cost to the business can get very cumbersome. With a 401k plan, a company allows the employee to choose their own contribution, and then offer usually a much smaller employee match.

4) You must not have common ownership in any of the employers you work for. As soon as you have common ownership because you started the company or you and your wife started the company, the IRS has new limitations of contribution for you. The IRS doesn’t want you to open up 10 different companies, spread out your millions in income, and defer $550,000 ($55,000 X10) in tax free earnings in your retirement.

5) You’ve got to remove your limiting beliefs about how much you can make as a sole proprietor. If you think making $220,000+ as an employee is difficult, wait until you try making $220,000+ with your own two hands from nothing! But like anything that is done over a long enough period of time, things get better due to experience, expertise, and higher rates.

Come retirement time, we’ll still have to pay taxes on all our pre-tax contributions when it’s time to withdraw funds. By then, we’ll surely be able to tactfully withdraw money in a way that gets taxed the least. Chances are higher that when we’re in our 60s, 70s, 80s, and beyond, we won’t be making as much money as when we were working anyway.

Historical 401k Contribution Limits

2021 401k limit contribution is the same as 2020. Hopefully the 401(k) maximum contribution limit goes up to $20,500 in 2022.

Historical 401k contribution limits for pre-tax retirement account savings

Note: I’m not a tax accountant. It’s always worth speaking to a tax advisor about such things. 1099 income for an independent contractor/sole proprietor is tricky and you would have to make closer to ~$260,000 income to get to max out at $56,000 (for 2019) due to taxes and adjustments for a SEP-IRA. 

The biggest confusion people have is thinking $56,000 is the limit across all accounts. I thought the same thing too. $56,000 for 2019 is the maximum you, the individual/sole proprietor/owner of your business can contribute. But if you are somehow an amazing person who can get employers to hire you, pay you lots of money, and contribute the max $56,000 a year, then it’s the individual company’s choice to contribute to your retirement up to the maximum if they wish. It helps to think like an employer when it comes to such dynamics. 

Diversify Your Investments Into Real Estate

Stocks are very volatile compared to real estate. Therefore, if you want to dampen volatility and build wealth at the same time, invest in real estate. Real estate is my favorite asset class to build wealth.

The combination of rising rents and rising capital values is a very powerful wealth-builder. Further, investing in real estate is very tax efficient. Depreciation is a non-cash expense that lowers your taxable rental income. Further, you get to sell a property $250,000/$500,000 tax-free if you live in it two out of your last five years!

In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 with real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.

Take a look at my two favorite real estate crowdfunding platforms. Both are free to sign up and explore. 

Fundrise: A way for accredited and non-accredited investors to diversify into real estate through private eFunds. Fundrise has been around since 2012 and has consistently generated steady returns, no matter what the stock market is doing. For most people, investing in a diversified eREIT is the easiest way to gain real estate exposure. 

CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations, higher rental yields, and potentially higher growth due to job growth and demographic trends. If you have a lot more capital, you can build you own diversified real estate portfolio. 

Free Tool For Retirement Savings

I recommend signing up for Personal Capital, the best free financial management tool online. It helps you track your net worth, analyze your investments for excessive fees, and manage your cash flow. I ran my 401k through their 401k Fee Analyzer and found out I was paying $1,700 a year in fees I had no idea I was paying!

Personal Capital has an incredible Retirement Planning Calculator that uses your linked accounts to run a Monte Carlo simulation to figure out your financial future. You can input various income and expense variables to see the outcomes.

Retirement Planning Calculator
Sample retirement planning calculator results
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Filed Under: Retirement, Taxes

Author Bio: I started Financial Samurai in 2009 to help people achieve financial freedom sooner. Financial Samurai is now one of the largest independently run personal finance sites with about one million visitors a month.

I spent 13 years working at Goldman Sachs and Credit Suisse. In 1999, I earned my BA from William & Mary and in 2006, I received my MBA from UC Berkeley.

In 2012, I left banking after negotiating a severance package worth over five years of living expenses. Today, I enjoy being a stay-at-home dad to two young children, playing tennis, and writing.

Order a hardcopy of my upcoming book, Buy This, Not That: How To Spend Your Way To Wealth And Freedom. Not only will you build more wealth by reading my book, you’ll also make better choices when faced with some of life’s biggest decisions.

Current Recommendations:

1) Check out Fundrise, my favorite real estate investing platform. I’ve personally invested $810,000 in private real estate to take advantage of lower valuations and higher cap rates in the Sunbelt. Roughly $150,000 of my annual passive income comes from real estate. And passive income is the key to being free.

2) If you have debt and/or children, life insurance is a must. PolicyGenius is the easiest way to find affordable life insurance in minutes. My wife was able to double her life insurance coverage for less with PolicyGenius. I also just got a new affordable 20-year term policy with them.

3) Manage your finances better by using Personal Capital’s free financial tools. I’ve used them since 2012 to track my net worth, analyze my investments, and better plan my retirement. There’s no better free financial app today.

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Comments

  1. David says

    December 10, 2021 at 8:37 pm

    Correction:

    “Furthermore, you can contribute to a traditional IRA because you make too much. Therefore, what is a retirement super saver supposed to do if s/he wants to save more than $19,500?”

    Should have been can’t?

    Reply
    • Financial Samurai says

      December 10, 2021 at 9:38 pm

      Good catch! You are correct.

      Reply
  2. Sebastian says

    January 7, 2021 at 7:40 pm

    I like how you said making $220,000+ from nothing. This is the hardest thing I have ever done in my life nothing even comes close to many other things I’ve done losing weight, etc.

    Reply
  3. fST says

    December 8, 2018 at 7:53 pm

    What if you’re a W2 employee for a company but then also get 1099 income from that same company for your business? Would you still get the same 56k/year limit for each with a 401k for one and SEP IRA for the other?

    Reply
  4. Kevin says

    February 12, 2018 at 8:11 pm

    Sam,

    What if you are an employee of 2 different companies? One offers a sep ira and the other a 401k? I am in such scenario. My employer with sep ira will max the $55k per year for me at 20% contribution. Can I also max my other employer’s 401k at $18.5k/year plus get the match? Thanks!

    Reply
  5. multimillionaire says

    December 16, 2017 at 9:37 am

    Sam, there is one key tax you did not talk about when it comes to savings in income taxes.
    For all the self-employed IRAs and 401Ks, one can contribute to all those plans if they have earned incomes. One has to pay self-employment taxes on earned incomes which is about 15.3% (social security plus medicare). Hence the net savings in income taxes have to account for the self employment taxes one has to pay. The bottom line is the savings will be reduced by the self employment taxes.

    Reply
  6. Veiled says

    November 5, 2017 at 3:13 pm

    How do 403(b)s treated in all of this? Are they basically equivalent to 401(k)s?
    What if you want to do a backdoor Roth and need to have zero money in all IRAs by December 31? If your consulting/contractor work was in a SEP-IRA, could you move that money by December to take advantage of the backdoor Roth?

    Reply
  7. Steve says

    August 19, 2017 at 12:31 pm

    First of all, that I you for your very interesting article. I hope you have your trade name protected under the Trademark statute. It’s a great name.

    Now for my questions: Let’s say, hypothetically, I’m an attorney age 55 and own my own law practice that is organized as a PC in Texas. Through the PC, I provide legal advice to my clients. Through a separate business, an LLC, owned entirely by me, I do consulting work that is not legal advice (I sometimes testify as an expert witness, give speeches or write articles).

    The PC has a 401(k) and I contribute to the max. Based on your research, how much can I contribute as the employer to my 401(k)?

    The LLC currently does not have anything setup for retirement. Based on your research, what is the best option?

    Again thank you for your blog. I agree that is well written and your research demonstrates that you are truly … a financial samurai.

    Reply
  8. A S says

    August 19, 2017 at 9:29 am

    Hi Sam,

    Why do you need 212k income from your own solo owned business to put 54k in the Solo 401k?

    From my understanding of you have your own S corp with you as the only owner and employee than you can run an annual salary of 144k for yourself. As an employee deferral you contribute 18k into the Solo 401k and as an employer match you contribut 36k (25% of gross wages 144k) into the Solo 401k. This will help you reach the 54k max with a gross income of 144k on W2 from your own S Corp (or any entity for that matter).

    In other words, if my business earns 144k (plus some more to cover taxes or fees etc) and it pays me a 144k salary then I could still put aside 54k pre tax into a Solo 401k.

    Is this understanding correct?

    Please revert and thanks for this great website.

    Reply
    • Financial Samurai says

      August 19, 2017 at 1:13 pm

      This may be correct. See: How Much Can You Actually Contribute To Your Solo-401k?

      Reply
  9. Torie says

    August 9, 2017 at 2:33 am

    Hello! The content on this website is amazing (especially for those self-employed like me now)!

    I’m trying to max out my the employer side of the 54k I can contribute. I can contribute 54k towards my single-person LLC. What is required to be an “employee” of the firm? I assume being an uber driver, independent contractor for mystery shopping, real estate agent, these things all do not apply?

    Has anyone gotten a part time (high paying) job with a company part time? And if I do so, I can only contribute 25% of my salary with the company? If presented with a salary, has anyone ever asked for their salary in the form of a 401k “bonus/matching/etc” from the company instead of receiving the salary? So if you were offered making 100k a year with a company, ask for 36k in discretionary bonus, and have your salary on paper be 65k?

    Sorry for all the question, hopefully someone has had experience with all this :)

    Reply
  10. Tip Lee says

    February 27, 2017 at 1:52 pm

    Hey Sam, If my wife is in school and does not have a W2 job, but makes $ on the side by doing some independent contractor work, selling stuff on craigslist, etc, can she setup a solo 401k and dump all the income into that account and thus avoid paying any taxes on that income right now? (by “all income” i mean less than the $18,000 max)
    Also when you have a solo 401k for a side business, if you are a sole proprietor does the business have to be one specific thing? or can you make money doing a variety of different things and consider it all the same business?

    Thanks, Tippy

    Reply
    • Financial Samurai says

      February 27, 2017 at 9:00 pm

      Check out: How Much Can I Contribute To My Self-Employed 401k for the contribution formula.

      Reply
  11. Kristin says

    December 5, 2016 at 2:56 pm

    In an earlier comment

    “~$424,000 is just the simple theoretical income amount one has to make combined between two entities to be able to contribute $106,000 in pre-tax retirement contributions. One has to make $424,000 across two entities, ideally at around a $212,000 split to max out $53,000 each. ”

    SO:
    My husband and I are business partners can we EACH contribute 53K to our individual SEP IRA’s?
    My CPA can’t seem to give me a straight answer.

    Thanks!

    Reply
    • Financial Samurai says

      December 5, 2016 at 3:03 pm

      What is your income each? i’m surprised your CPA cannot answer you. You must contribute the same percentage of your income across all employees.

      Reply
      • Kristin says

        December 5, 2016 at 4:16 pm

        Last year combined we made ~437K total. Yes, We did the same percentage (~11.5%) between us and our one employee BUT OUR total for BOTH (mine and my husband’s) SEP IRA was 53K total. I’m trying to figure out if we could exceed 53K but not more than 106K, while keeping the equal % across the board. I’m not sure of our income total this year yet.
        MY CPA just recited the IRS website to me which I have already read and does not seem to clarify our specific circumstance.
        My investment banker seems to think we should be able to contribute more than.
        I appreciate your help.

        Reply
        • Financial Samurai says

          December 5, 2016 at 5:10 pm

          Kristin, you guys are two separate people, even though you are married. With a 401k, married employee couples can each contribute $18,000 pre-tax max. I don’t see what the difference is with a SEP IRA. Two people, two retirement accounts, two workers, two contributors.

          I’m afraid to give you or anybody public tax advice b/c taxes are so darn confusing and I don’t know your full financial situation. I just know about my situation and used my example of how I could contribute to a self-employed 401k and also receive SEP IRA contributions from my employer.

          Good luck and let me know what you finally decide to do. Also, how did you find my article btw? FS has been around since 2009. Feel free to check out my About page for more background info and my other tax-related articles.

          Sam

          Reply
          • Kristin says

            December 5, 2016 at 6:57 pm

            I am going to consider us each individual entities and therefore contribute more that 53k total. I think that seems to make more sense.

            I googled my question and your article was one of the top few that appeared on search.

            I will look into other articles for yours, thanks you!

            Reply
            • DJ says

              May 27, 2017 at 10:27 pm

              If I understand correctly in this scenario you could have sheltered the full 53k for both you and your husband in a solo 401k. 18,000 for you, + the business’ contribution of 25% of employee earnings or 20% of business earnings (not sure which) could net you a maximum of 53k.

              All “employer” contributions are given to both employees. So he’ll get the same 20% or 25% from the business that you did as well as his own 18k contribution.

              Solo 401k’s allow a little higher contribution than SEP if you’re over 50 with the “catch up” feature allowing up to 120k per year (2017) in tax deferred savings in a scenario like yours. I haven’t seen the same scenario confirmed with a SEP or I’d happily share my data on it.

              I’m just an enthusiast and have probably horribly bastardized half the terms here, but I do believe it’s possible from my research. I hope this might be helpful to you next tax season.

              Reply
  12. Tip Lee says

    December 2, 2016 at 12:36 pm

    Hey Sam,
    Quick question in regards to individual/Solo 401k’s. So if i have a side business that generates $10,000 a year after operating costs, I can only contribute 25% of the $10,000 into my Solo 401k or Individual 401K? Or could i put the entire $10,000 into it and essentially have zero net income from that job?

    Thanks for the great posts.
    Aloha, Tippy

    Reply
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