Many employers offer qualified retirement plan accounts — such as 401(k), 403(b) and 457(b) plans — that provide employees with tax-deferred savings options. Contributions to these retirement plan accounts are made with pre-tax dollars, and they reduce an employee’s taxable income for the year that contributions are made.

Some employers also offer Roth versions of these accounts that allow employees to contribute after-tax dollars. A new law — the Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0) — now extends the Roth option to SIMPLE IRAs and simplified employee pensions (SEPs).

Basic Retirement Options for the Self-Employed

SIMPLE IRAs and SEPs are two basic retirement plan options that often make sense for self-employed individuals. Contributions to both types of accounts are completely discretionary, and these accounts are easy to set up and administer. Here’s more on how they compare:

SIMPLE IRAs. For 2023, a self-employed individual can make a deductible contribution to a SIMPLE IRA of up to $15,500 of net self-employment income to the account, plus a “matching contribution” of up to 3% of self-employment income. At modest income levels, the maximum deductible contribution to a SIMPLE IRA may be considerably larger than what would be allowed under the other tax-advantaged retirement plans. For 2023, an additional “catch-up” contribution of up to $3,500 is allowed to a SIMPLE IRA if you’ll be 50 or older as of December 31, 2023.

Important: Under SECURE 2.0, starting in 2025, the catch-up contribution limit to SIMPLE plans for employees ages 60 to 63 will increase to the greater of: 1) $5,000, indexed annually for inflation, or 2) 50% more than the regular catch-up amount in 2025.

You must set up a SIMPLE IRA plan by October 1 of the year for which you want to make your initial deductible contribution. So, if you want to deduct a contribution for the 2023 tax year, you must set up your SIMPLE IRA no later than October 1, 2023. However, you can make contributions until the extended due date of your 2023 tax return.

There are some major downsides to choosing SIMPLE IRAs. First, if you have significant self-employment income, other types of plans may allow larger annual deductible contributions. In addition, contributions must be made to any employees on your payroll — and they’re immediately 100% vested.

SEPs. A SEP is a defined-contribution plan. For 2023, the maximum deductible contribution is $66,000. But the contribution is limited to 25% of net self-employment income reduced by the deduction for half of your self-employment tax. You can set up and fund a SEP as late as the extended due date of the tax return on which you claim your initial deduction.

There are some potential downsides, however. Notably, for 2023, annual employer SEP contributions may be required for any employee who 1) is at least age 21, 2) has worked for you during at least three of the past five years, and 3) receives at least $750 of compensation. These contributions are immediately 100% vested.

In addition, there are no catch-up contributions for SEPs, because they’re funded by employer contributions only. Catch-up contributions apply only to employee elective deferrals.

New Roth Options

Before SECURE 2.0 became law, employees couldn’t treat contributions to SIMPLE IRAs and SEPs as nondeductible Roth contributions. That prohibition is now lifted. So, starting in 2023, contributions to SIMPLE IRAs and SEPs can be treated as after-tax contributions.

When pre-tax dollars are contributed to a SIMPLE IRA or SEP, they’re deductible in the current tax year. With the Roth versions of these accounts, you lose the current tax benefit, but when you withdraw funds from the account, “qualified distributions” are completely exempt from income tax. This can be a big upside if you expect higher taxes in the future.

Plus, unlike Roth IRAs, there are no income limits on participants in a Roth SIMPLE IRA or a Roth SEP — and plan participants are generally allowed to roll over pre-tax balances to a Roth account. Given today’s comparatively low individual tax rates, this could be a tax-smart move.

What’s Right for You?

Self-employed individuals are usually the ones who take advantage of SIMPLE IRAs and SEPs, so they’re not at the mercy of an “employer” to provide a Roth option. This new tax law provision provides self-employed people with enhanced flexibility to plan for their retirement. However, you may need to update plan documents to allow Roth contributions.

Taxes are just one factor to consider when designing a retirement saving plan. It’s also important to evaluate how much cash you have on-hand to contribute to your nest egg. Contact our tax specialists to help find the optimal solution for your small business.

Visit our SECURE Act 2.0 Knowledge Center for more information on retirement changes that could impact you and your business.