Comparing the SEP IRA to the Solo 401k

We are nearing the end of the year and if you’re self-employed and don’t have a retirement plan in place, now is the time to get one.  Here we will focus on two options, the Simplified Employee Pension or SEP IRA and the Solo 401(k) plan.  Each has it’s own pros and cons and one of them may be more suited to your particular needs.

The SEP IRA is a great retirement plan option for small business ownersFirst off, the SEP IRA.  You can open this type of plan at virtually any major custodian.  You can invest in anything you can with a standard IRA account.  You can contribute to the plan up until your tax deadline and any extensions.  For most people, that day is today, October 15.  There are very little reporting requirements.  For 2013, you may contribute up to 25% of compensation or $51,000, whichever is less.  All contributions are made by the business itself; meaning employees (if you have any) do not contribute directly to the plan.

As for the Solo 401(k), it includes both an employee deferral program and an employer deferral piece.  The combined contribution limit is $51,000 for 2013 plus another $5,500 if you are at least age 50.  They too can be opened up at most major custodians.  They are limited to solo employees, spouses and business partners.  If you have other employees that work for you, you cannot utilize the Solo 401(k) plan.

Let’s compare and contrast these two different plans.  As stated, the Solo 401(k) is primarily for sole proprietors while the SEP IRA can be used if you have employees.  It could get expensive if you have many employees since you have to contribute on their behalf the same percentage you defer for yourself.  Each plan will allow you to contribute up until you tax filing date, including extensions, for the prior tax year.  You must establish a solo 401(k) plan by the end of the calendar year.

You SEP IRA contribution is calculated as a percentage of compensation.  Therefore, if your compensation fluctuates from one year to the next, so will the amount you are allowed to contribute to a SEP.  On the other hand, you may contribute up to $17,500 ($23,00 if you are age 50+) to a Solo 401(k) plan in addition to the profit sharing contribution.  This is a better option for those looking to put aside more money for retirement.

Two other advantages of the Solo 401(k) is the available loan option or the Roth option.  You can take a loan out at anytime from your 401(k) plan; you cannot take a loan from your SEP IRA.  Also not found in the SEP IRA is the Roth feature which allows you to contribute after-tax dollars to your 401(k) and see tax-free withdrawals during retirement.  This is assuming your custodian allows for a Roth feature.

Both types of plans are easily maintained with limited paperwork involved.  They can each be opened at your usual financial institutions and investment options run in line with most other plans out there.

Depending on your unique situation and business, one of these plans might work for you or another option might be better.  The tax professionals at the IRA Financial Group can break down each type of plan and figure out which one is more advantageous to you.  Give them a call at 800.472.0646 or visit their website today to see all available plan options they offer.

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