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Solo 401k vs SEP IRA: Which Is Best for Small Business Owners?

Posted by MB Group on May 27, 2020 2:18:00 PM

The benefits of owning a business are many, yet there is one substantial downside: you're responsible for savingsolo 401k vs SEP IRA for your own retirement. And unless you're planning on working forever, this is a big deal. Fortunately, there are multiple retirement plan options designed for small business owners. 

Two of the most popular are the solo 401(k) vs SEP IRA. If you're deciding between a solo 401(k) vs a SEP IRA and you have employees, your choice is simple: SEP IRA because you're not able to open a solo 401(k) if you employ anyone other than a spouse. If both options are available, deciding which one is best for you and your business can be confusing. To shed light on the matter, the experts at MB Group have created a quick comparison between the solo 401(k) vs SEP IRA. Let's take a closer look at some of the similarities and differences between the SEP IRA vs solo 401(k). 

What Is a Solo 401K? 

A sole participant 401(k) or solo 401(k) is a specialized retirement plan for those who are self-employed. The solo 401(k) allows you to stash away money for your retirement in excess of Roth or traditional IRA limits. As we previously mentioned, you are only able to open a solo 401(k) if you and your spouse are the only employees of your business. 

How Do Solo 401(k)s Work? 

As you can probably deduce, solo 401(k)s work similarly to its corporate counterpart. Business owners who have a solo 401(k) will fund it on a pre-tax basis, and the investments will enjoy tax-free growth. On the other hand, you can fund it with after-tax dollars in the Roth solo 401(k), which will not reduce your taxable income. With the Roth solo 401(k)s, your earnings will be tax-free when you make qualified withdrawals. A few key highlights of a solo 401(k) include:

  • As an employee, you can contribute up to $19,000 a year to your solo 401(k). 
  • If you are at least 50, you are allowed to contribute an extra $6,000
  • As the employer, you can contribute up to 25% of your compensation to your solo 401(k).
  • Your total employee and employer contributions couldn't' exceed $56,000 in 2019 if you're under 50; and
  • Those over 50 couldn't exceed $62,000 in 2019. 

What Is a SEP IRA?  

If you are a business owner and have a few employees, your best option may be the Simplified Employee Pension (SEP) IRA. The SEP IRA allows you to make contributions to your own retirement savings account as well as your employees. 

SEP IRAs work similarly to the traditional IRA, which means contributions are tax-deductible and the proceeds enjoy tax-free growth. You will, however, pay taxes on distributions for qualified withdrawals in retirement. 

Employee Contributions

With a SEP IRA, you must contribute to the account of every eligible employee if you are contributing for yourself. In addition, all eligible-employee contributions must match the compensation percentage you contribute toward your own. For example, if you contribute 15% of your salary, you must also contribute 15% of each eligible employee's compensation to their individual plan. Eligible employees must meet the following criteria:

  • Have worked for you during three of the previous five years
  • The employee is at least 21 years old
  • They have earned a minimum of $600 from you in the previous year

How Do SEP IRAs Work? 

The SEP IRA works very similarly to an IRA. When you open the SEP IRA, you'll have access to a range of funds that you can use to build your portfolio. Some of the most common investment options include bonds, stocks, exchange-traded funds, target-date funds, and even mutual funds. 

Solo 401(k) vs SEP IRA: Which Option Is Best for Small Business Owners

For several years, the SEP IRA was considered to be the premier choice for self-employed people to save for retirement and slash their tax bills. On the other hand, plans like the 401(k) were considered to only be suitable for the big budgets of large corporations. Today, times have changed and the solo 401(k) has been crowned the new king of self-employed retirement plans. 

One of the key bevels in the crown of the solo 401(k) is the fact you'll make pre-tax retirement contributions. Another shiny bevel that makes the solo 401(k) the superior option is you can contribute both as the employee and employer. This powerful attribute allows you to contribute more to your retirement and a spouse's retirement compared to a SEP IRA. As an added bonus, solo 401(k)s are easy to open and relatively cost-effective solutions. 

Contact MB Group 

If you're a small business owner and looking for the best solution to save for your retirement, the business consultants and CPAs at MB Group can help. 

Contact the MB Group today to learn more about saving for the future you've always envisioned. 

Topics: Retirement

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