In 2023, Workers Can Increase the Size of their Tax-Deferred Retirement Savings.

The IRS has released retirement contribution limits for 2023, and there is a large gap between what salaried employees can save and what self-employed workers can save. In 2023, some workers will be eligible for a tax break that will allow them to increase the size of their tax-deferred retirement savings significantly.

Contributions to a 401(k) plan at work are capped at $22,500 per year, or $30,000 if you’re over age 50 and eligible for catch-up contributions. Traditional IRAs and Roth IRAs have much lower contribution caps of $6,500 and $7,500, respectively; those 50 and over can contribute an additional $1,000.

Self-employed individuals can contribute up to $66,000 to a SEP IRA or a solo 401(k) plan. The catch is that independent contractors pay taxes not only as employees but also as business owners.

There are some caveats to this. The Internal Revenue Service requires that sole proprietors submit a Schedule C, Profit or Loss from Business (Sole Proprietorship), with their annual tax returns. This means that the days of keeping cash transactions off the books and out of the hands of the taxman are over.

You’ll have to create a new account, too. Large investment companies and others offer this service, along with the associated costs and paperwork. However, some places like Fidelity, Schwab, and E*Trade don’t charge fees.

As an employee, you can put up to 25% of your net income into a SEP IRA, up to a maximum of $66,000. As a self-employed person, your SEP-IRA contributions and half of your self-employment tax will be deducted from your net earnings.

The maximum annual employee contribution to a 401(k) plan is $22,500; however, a self-employed person can put away 100% of their income in a solo 401(k). Additionally, the company can contribute $43,500 in profit-sharing contributions up to the maximum of $66,000, plus an additional $7,500 in “catch-up” funds for employees over 50. Your total 401(k) contributions for the year must be, at most, the annual limits.

Consequently, if you are also putting money away in a 401(k) at work, you must count those contributions toward the annual maximum of $66,000. Depending on your income level, you can put money into a traditional or Roth IRA up to the IRS maximum.

Like many workplace plans, the solo 401(k) allows account holders to borrow money from their retirement savings. Those with a 401(k) but are single can take out a loan of up to $50,000 if necessary. They can borrow the lesser of either half of the account’s value or the balance.

The ability to reduce your adjusted gross income (AGI) on your tax return is yet another incentive to use a SEP IRA or solo 401(k) for retirement savings.

This reduces your taxable income and helps high-earning self-employed individuals bring their adjusted gross income down to the level where they are eligible for the qualified business deduction. The 20% reduction in taxable business income significantly reduces their overall tax liability.

Make sure you know the current contribution limits to your place of workplace retirement plan before making any contributions.

If you are under 50 in 2023, the maximum 401(k) contribution you can make is $22,500. If you’re 50 or older, you can put in as much as $30,000 to your 401(k) plan, including the maximum catch-up contribution of $7,500.

However, whether you choose a SEP IRA or a solo 401(k), there are advantages to being self-employed. When you’re self-employed, you’re effectively both an employee and a business owner.