Investors who are owners of very small companies (ten employees or less) often compare the benefits of a Solo 401(k) with a SEP IRA. Below is a comparison of the two plans and the unique benefits that each qualified plan has to offer employers and employees. What is a SEP IRA?
Simplified Employee Pensions, or SEP IRAs
, are a popular employer plan for self-employed individuals. With a SEP IRA, you can choose the percentage of contribution for any given year (0-25% of earned income) for yourself and your staff. The only requirement is that the contribution percentage, in any year, be the same for each employee. Additionally, SEP IRAs offer significantly higher contribution limits than Traditional or Roth IRAs. What is an Solo 401(k)?
An Solo 401(k)
plan is simply a 401(k) plan for companies with no employees. Solo 401(k) plans have the same options available to them as larger 401(k) plans. However, with an Solo 401(k), the employer, trustee, and participant are often the same person. For self-employed persons or companies with no qualifying employees, a Solo 401(k) plan allows the employer/participant high annual contribution limits as well as a high degree of flexibility and convenience when it comes to acquiring assets.
Both a SEP IRA and a Solo 401(k) can be self-directed and invested into real estate, private equity, precious metals, and more. A SEP IRA requires an IRA provider to maintain the paperwork and bookkeeping of the account, per IRS rules. This is where it’s important for retirement investors to find a self-directed IRA provider who will maintain the booking for SEP IRAs.
Conversely, owners of a Solo 401(k) can serve as their own trustee and administrator, though these responsibilities often require more time and effort than most clients would like to exert themselves. This can be especially true for real estate, as disqualified persons and prohibited transactions rules can be complex for this asset type. Certain self-directed IRA providers can maintain the booking and paperwork for Solo 401(k) accounts.
A SEP IRA account holder has the ability to fund a SEP IRA with annual contributions, transfers from other IRAs, and employer plan rollovers. A Solo 401(k) is funded by a combination of employer and employee-contributions, which means tax advantages for both parties. Annual contribution limits are higher for Solo 401(k)s than for individual accounts, including SEP IRAs if you’re over 50 years of age. Plan earnings with an Solo 401(k) are unlimited and tax-deferred.
Solo 401(k) owners can contribute $18,000 a year ($24,000 if you are 50 or over), in addition to 25% percent of their salary or self-employment income. According to News Times, one strategy investors can use to take advantage of a significant tax-savings is to couple their Solo 401(k) with an S-Corp. In this way, self-employed individuals can keep their FICA amounts low, and still save the same amount as a SEP IRA, but with tax efficiency.
SEP IRAs have significantly lower start-up costs compared to any other retirement plan. Additionally, with a SEP IRA, investors’ businesses pay no taxes on investment earnings. Solo 401(k)s can choose whether their plan includes Roth contribution provisions, loan provisions, etc.
Both plans offer their own unique set of advantages, depending on an investor’s specific retirement goals. Feel free to contact New Direction IRA
today to learn more about these account types and the many other account types available for self-direction. Happy investing!