This is the second in a two part series on retirement for entrepreneurs. You can read part I here.
So you took last weeks advice and began maxing out an IRA, now what? If you are a solopreneur (an entrepreneur with no other owners or employees), as most entrepreneurs are, it may be time to open a company retirement plan. For most people, this will come down to two choices, a solo 401(k) or a SEP.
What are They
A solo 401(k) or SEP retirement plan allows you to contribute a portion of the earnings from your business towards your personal retirement savings. Even better, the amount you contribute can be written off against your taxable income. But what really sets these plans apart from IRA’s is the amount you can contribute. Both the solo 401(k) and the SEP allow you to contribute a maximum amount of $51,000 if your income meets certain levels.
Assuming you are in the 25 percent tax bracket, contributing the max to a solo 401(k) or SEP would generate a tax savings of $12,750. So you contribute $51,000 towards your own retirement savings and Uncle Sam slashes almost $13,000 off your tax bill. If there’s a better opportunity for tax savings, I haven’t seen it yet.
What’s the Difference Between Them
Although the solo 401(k) and SEP are similar in many ways, there are some differences. Let’s take a look at the characteristics of each.
– Allows you to contribute up to 100 percent of the first $17,500 in business income and an additional 20 percent of remaining income up to a maximum of $51,000 per year, plus an additional $5,500 for those age 50 and up.
– Allows you to take out loans of half the total value of the plan up to a maximum of $50,000.
– Usually has greater administrative responsibilities and management fees than SEP.
– Allows you to contribute up to 20 percent of your business income up to a maximum of $51,000.
– Very easy setup and low fee’s.
– Does not allow additional contributions for those age 50 and up.
Which is Best for Me?
As you can see, both plans appear to be very similar, but there are some differences that could make one plan better for you than the other.
If you are age 50 or over and plan to contribute the maximum, the solo 401(k) likely offers you significantly higher contribution limits. And if you feel you may want to take a loan out against the plan in the future, the solo 401(k) is your only option.
On the other hand, if you are under age 50 or don’t intend to contribute the maximum amount, the SEP offers significantly easier setup and management of the plan and also usually comes with less fee’s attached.
But like with the IRA, which option you choose is far less important than just choosing one and getting started. Both plans offer the opportunity for significant tax savings while also setting you up for retirement.
If you want to cut your tax bill while also funding your retirement, entrepreneurs have two great options in the solo 401(k) and the SEP.