Using ETFs in a Self-Employed Retirement Account

Self-employed workers and small-business owners can hold ETFs in solo 401(k)s and SEP-IRAs, often at a lower cost and with broader investment choice than proprietary mutual fund lineups. The contribution limits that apply to these accounts—which are substantial—make the choice between ETFs and mutual funds meaningfully consequential over a 20- or 30-year accumulation window.

Account types and ETF eligibility

A self-employed individual or small business owner can set up a solo 401(k) (also called an individual 401(k) or self-employed 401(k)) or a SEP-IRA. Both allow you to save far more than a traditional IRA ($7,000/year for those under 50), making them the backbone of tax-deferred retirement saving for business owners.

ETFs are fully eligible in both account types. You can hold any publicly traded ETF listed on the NYSE or NASDAQ, just as you would stocks or bonds. There are no restrictions, no “qualified list” of mutual funds only, no proprietary fund requirements. This is a key advantage over plans offered by some custodians or brokerages that default to their own mutual fund families.

Solo 401(k) contribution limits

The solo 401(k) is attractive because it allows you to contribute as both employer and employee. In 2024, you can contribute up to $69,000 total ($76,500 if you’re 50+). The limit breaks down as:

• Employee deferrals: up to 100% of compensation, capped at $23,500 (or $30,500 with catch-up).
• Employer contribution: up to 25% of net self-employment income.

For a freelancer earning $150,000 of net business income, you might contribute $23,500 as an employee deferral plus roughly $28,000 as an employer contribution, totaling ~$51,500 in that year. Across a 30-year career, that’s $1.5 million or more flowing into the account, all growing tax-deferred.

If that money is held in low-cost ETFs (say, 0.05% expense ratio) versus actively managed mutual funds (0.75% ratio), the difference in compounding is dramatic. Over 30 years, the 0.70 percentage point annual drag could easily cost you 15–20% of final account value—tens of thousands of dollars.

SEP-IRA structure and limits

A SEP-IRA (Simplified Employee Pension IRA) is simpler to administer than a solo 401(k), but has a lower contribution ceiling. You can contribute up to 25% of your net self-employment income, with a 2024 cap of $69,000. There’s no employee deferral component; it’s all employer contributions.

For a solo consultant earning $200,000, a SEP-IRA allows a $50,000 annual contribution (25% of $200,000). A solo 401(k) would allow ~$70,000 or more in the same scenario. The difference favors the 401(k) if you want to maximize tax-deferred savings.

Regardless of the account type, ETFs and mutual funds have identical tax treatment inside the account. Contributions are deductible, growth is tax-deferred (or tax-free in a Roth), and you don’t pay tax on capital gains or dividends while the money is in the account.

Cost advantage over plan-restricted mutual funds

Many custodians and financial advisors push proprietary or affiliated mutual funds—especially R-share classes—into self-employed retirement accounts. These funds often carry expense ratios of 0.50–1.00% or higher. By contrast, index-tracking ETFs on the same underlying indexes cost 0.03–0.15%.

Over a 30-year window with $1.5 million accumulated, that 0.75% difference in annual fees translates to roughly $300,000–400,000 in foregone growth—wealth transferred to the fund company instead of your retirement.

Example:

• Account value after 25 years: $1.2 million (assuming 6% annual return)
• If held in 0.75% mutual fund R-shares: 5.25% net return, final value ≈ $1.9 million
• If held in 0.05% index ETF: 5.95% net return, final value ≈ $2.15 million
• Difference: ~$250,000 in additional retirement capital

This advantage compounds. An investor who switches from high-cost mutual funds to low-cost ETFs at age 40 can expect significantly higher retirement savings at 65 or 70.

Choosing the custodian

Not all custodians or brokers treat ETFs equally. Before opening a solo 401(k) or SEP-IRA, confirm:

1. Commission-free trading: ETF purchases should not incur per-transaction fees.
2. Broad ETF access: Avoid custodians that restrict you to a short whitelist.
3. Account flexibility: Can you rebalance, switch between ETFs, or hold dividend-paying ETFs without penalty?
4. Annual fees: Some custodians charge $100–300/year for account maintenance; some don’t.

Major brokers (Fidelity, Schwab, Vanguard, E*Trade) offer commission-free ETF trading and unrestricted selection within their retirement accounts. Smaller or employer-plan specialists may be more restrictive.

Roth option

If you have income flexibility, a Solo Roth 401(k) allows you to make after-tax contributions with tax-free growth and withdrawals in retirement. ETFs held in a Roth grow tax-free, making them especially attractive for long-horizon investors expecting strong appreciation. You can hold the same broad range of ETFs in a Roth 401(k) as in a traditional solo 401(k).

Asset allocation and rebalancing

Because you control the account and aren’t locked into a plan’s default offerings, you can build a tailored asset allocation. You might hold a total-market index ETF, a bond ETF, an international equity ETF, and real-estate or sector-specific ETFs—all with razor-thin cost ratios.

Rebalancing from ETFs is straightforward: you simply sell the overweight position and buy the underweight, all within the tax-sheltered account. No tax consequence, unlike rebalancing taxable holdings.

Withdrawal and RMD mechanics

Once you reach age 73, you’re subject to required minimum distributions (RMDs) from traditional solo 401(k)s and SEP-IRAs, calculated on account balance and life expectancy. ETF holdings are valued at market price for RMD purposes, just like any other security. You can satisfy an RMD by selling ETFs or, if the custodian permits, transferring ETF shares in-kind to a taxable account.

A Roth solo 401(k) has RMD requirements too, but a Roth IRA (if you convert or fund it directly) does not, making it a powerful tool for those who want to leave wealth to heirs.

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