The SEP IRA or Solo 401K – Which Should You Choose?
Executive Summary:
A common question many people face is whether they should set up the SEP IRA or Solo 401K if they are a 1 person firm. One must determine the structure of their business. Are they filing self-employed or are they a corporation? This matters. Depending on the filing status of the business, this can mandate the eligibility and contribution limits to either plan. In accordance with the contribution limits, the age of the business and whether the business has employees will dictate the choices as well. With this said, if it were up to me, if you are eligible for either, the Solo 401K, is the optimal choice.
Let’s begin with looking at the SEP IRA.
The SEP IRA, or Simplified Employed Pension, can be set up by anyone that owns a business, regardless of how many shareholders and employees work for the firm. The caveat – any and all non-shareholder employees who have worked at the firm and meet the following guidelines must also be paid the same contribution percentage:
- Over 3 years
- Are over 21 years old
- And works full time (considered 1000 hours)
Therefore, if the owner(s) are wanting to fund their retirement at a 25% or even 15% contribution, all non-shareholder employees that meet the above guidelines must also be funded at the same 25% or 15% contribution. So this can be costly for the employer.
However, if your business has no employees that work with the firm, other than you and/or your spouse, you have the option for funding a Self Employed 401K, or commonly referred to as a Solo 401K. The Solo 401K is only for a 1-2 person business where the owner(s) are spouses.
So, which is better, the SEP IRA or the Solo 401K?
An advantage to the Solo 401K right off the bat is that individuals over 50 are permitted to contribute $6,000 more than inside of a SEP IRA. The Solo 401K allows for more tax sheltering and deductions than a SEP IRA. See the IRS 2019 contribution limits and rules: SEP IRA contribution limits | Solo 401K contribution limits
I recommended contacting a financial advisor or tax advisor to determine your maximum contribution limit. Depending on whether the business is filed as self-employed (schedule-C) or an S-Corporation, the contribution limits differ. If you pay yourself wages versus self employment income, contribution limits differ. Therefore, just because the business earned $250,000 does not mean the individual can contribute the maximum amount to their SEP. So, be careful when determining your contribution amount.
So, the advantage of the Solo 401K is that in order to maximize the 2019 contribution, you can pay yourself less in order to max out your tax deferred savings. This is a good thing. See what Forbes has to say. Should You Ditch The SEP-IRA For The Better Solo 401 (K) – Forbes
Email Matt.Ward@NewCenturyInvestments.com for help opening and determining your contribution limits to either the SEP IRA or Solo 401K.
Article by Matthew Ward – New Century Investments
*All contribution limits are based off of 2019 tax year. Eligibility rules may have changed for these plans. Please contact us or your qualified advisor to confirm your individual situation.
