The solo 401(k) and SEP IRA are two of the greatest retirement plans available to small business owners, including self-employed freelancers. During a difficult economy, it can be difficult to save for retirement. Still, these strategies are simple for small businesses to implement while producing significant tax breaks and preparing for the future. You need to know the information regarding the solo 401(k) and SEP IRA.
List of Contents
What Exactly Is a Solo 401(k)?
A solo 401(k) is a 401(k) plan suited for self-employed people. Thus, you cannot contribute to a solo 401(k) if you have full-time employees. However, you can use the plan to cover yourself and your marriage.
Qualifications for a Solo 401 (k)
What Exactly Is a SEP IRA?
Genuinely, SEP IRA stands for a Simplified Employee Pension Plan Individual Retirement Account. SEP IRAs are suitable for self-employed individuals and small business owners with few or no workers. Contributions to SEP IRAs for company owners are tax-deductible. Until retirement, investments grow tax-deferred, and distributions are taxed as income.
Qualifications for a SEP IRA
The Differences between the Solo 401(k) and the SEP IRA
Both the solo 401(k) and the SEP IRA allow you to save roughly the same amount of money a year. However, both plans differ in significant ways. Here are three significant distinctions between the two plans.
- Contribution rates
Despite similar annual contribution limits, the solo 401(k) allows you to save faster. The SEP IRA permits you to contribute 25% of your income to the account. In contrast, with a solo 401(k), you can save up to one hundred percent as an employee contribution, up to the annual limit, and then switch to employer contributions at a rate of up to 25%.
This 401(k) feature is especially advantageous if you have a secondary source of income that allows you to save money at a higher rate. However, keep in mind that your annual maximum contribution limit applies to the sum of all your 401(k) contributions.
- Viability for more employees
Except for a marriage who works in your business, the solo 401(k) is inapplicable to businesses with employees. In this instance, you may consider the SEP IRA, which allows you to set up a plan for several employees. When putting up a plan for your employees, you’ll also want to compare the SEP IRA to the SIMPLE IRA to see which is most effective.
- Roth options
If you need the tax-free growth of a Roth plan, your only alternative is a solo 401(k). In addition to pre-tax payments, the solo 401(k) also permits after-tax contributions. In contrast, the SEP IRA limits you to the restrictions of a traditional IRA, even though the yearly contribution maximum is far larger than that of the individual plan.
The Working Principles of Self-Employment Retirement Plans
To qualify for a self-employment retirement plan and its numerous advantages, you must make revenue from your own business. The solo 401(k) functions similarly to the employer-sponsored 401(k)s that millions of Americans already have.
The solo 401(k) is available in both standard and Roth forms, with their respective tax advantages. Moreover, it has the same yearly employee contribution maximum as a business 401(k) (k). In addition, it offers catch-up donations.
However, the solo 401(k) permits the owner to make additional contributions as an employer. Additionally, it is open only to one-person businesses, unless they employ a spouse.
Comparatively, a SEP IRA is only available in a pre-tax version. Members can contribute up to 25% of their salary, up to $61,000 per year, which is significantly greater than ordinary employer plans. Unlike traditional 401(k) plans, the SEP IRA does not permit catch-up contributions and does not offer a Roth (post-tax) option. A SEP IRA must otherwise adhere to the same restrictions regarding investments, distributions, and rollovers as a regular IRA.
Conclusion
With identical yearly contribution limits, the solo 401(k) and SEP IRA may appear to be comparable. However, the 401(k) may be the superior choice for freelancers working alone. The solo 401(k) plan allows you to save at a considerably faster pace, but is only available to one-person enterprises (or with a spouse). In addition, the single 401(k) offers an attractive Roth option, whereas the SEP IRA does not.
FAQs
A Solo 401(k), also known as an Individual 401(k), is a retirement plan for self-employed persons or small company owners with no workers outside their spouse. Contributing pre-tax cash helps individuals to save for retirement and perhaps lower their taxable income.
A Simplified Employee Pension (SEP) IRA is a retirement plan for self-employed or small business owners with no workers other than themselves or their spouse. Individuals are permitted to contribute pre-tax cash to the plan, so possibly decreasing their taxable income.
The answer to this question relies on your individual financial situation and objectives. When deciding between Solo 401(k) and SEP IRA, you should examine your income, the size of your firm, and if you intend to recruit employees in the future. It may be beneficial to visit a financial professional in order to identify which retirement plan best suits your needs.
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Source: Bankrate, Nerdwallet