SEP IRA Vs. Solo 401k: Making the right choice for your future

You are not a financial expert, but you are expected to know the ins and outs of each product when they are presented before you to buy. For retirement, self-employed business owners generally have two options for funding their retirement:

The SEP-IRA, and the Solo 401k. 

What is a SEP IRA

A SEP IRA is similar to a regular IRA, or individual retirement account where contributions are tax-deductible. SEP-IRAs (and Solo 401ks) both require self-employment or business income.   

Why choose a SEP IRA?

This is one of the simplest plans and basically operates just like opening an IRA. 

Setting up your SEP IRA

When you open a SEP IRA account, you can set it up right up until the date you file your taxes. If you file an extension or your company has not been in business for a full year, this is an easy account to set up while you work through your tax situation. Contributions made to SEP IRA accounts are tax-deductible.

How much is your 25%?

Well…it depends on how your business is structured. If you file a schedule C, you’ll likely need to make an adjustment based on your self-employment taxes. There are many calculators that exist online to help you figure the maximum contribution amount for your particular circumstances.

Also..regular IRA and ROTH IRA accounts operate independently of business limits for SEP and SOLO 401ks.

Accessing your money

As mentioned before, one of the biggest draws of the SEP IRA is the tax-deferred growth until the money is withdrawn. If you elect to withdraw money from your SEP IRA before you turn 59 ½ years old, you may face an early withdrawal penalty.

What is a Solo 401k

The Solo 401k, or self-employed IRA, works similarly to a traditional 401k in that you can make deferrals. With a 401k, you can also make profit sharing contributions as well. 

Why choose a Solo 401k?

Don’t let the name fool you; the solo 401k can be for you or your spouse, or you and your business partner. If you are the only employee of your company, this is the ideal option for you. If you have full-time employees, or you plan to add employees, the solo 401k is no longer a viable option. With a SOLO 401k, you can: 

  • Up to $18,000 – pre-tax or after-tax – salary deferral option
  • Option for profit-sharing contribution between 20% and 25%, depending on your company’s tax filing
  • Option to catch up a maximum of $6,000 for account holders who are at least 50 years of age
  • Option to combine both salary deferral and profit-sharing options, up to $53,000
  • Ability to use designate deferrals as ROTH contributions

Setting up your Solo 401k

Setting up a solo 401K is more involved than a SEP a, but with guidance from a financial planner, you can get started right away. 

Unlike the SEP IRA, the account has to be created before the end of the year. You cannot wait to open the account and benefit from deductions if you wait until the following year. So long as the plan is established by 12/31, you can still make contributions up to the filing date of your business tax return. 

What Should You Choose?

Speak to a financial professional about the best choice for you, your company, and your family. If you are starting fresh,  the SEP IRA is a safe and simple choice. If you are a business owner or partner, with no plans to hire full-time employees, the solo 401k offers additional flexibility and contribution limits. 


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investing for retirement ebook ipad - McClain Lovejoy
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