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SEP IRA vs Solo 401(k): Which Should You Choose?

By   ·  2 minute read

The landscape of employment in America is evolving rapidly, with an increasing number of individuals opting for self-employment. According to the Bureau of Labor Statistics, over 16.5 million Americans identified as self-employed in September 2023, constituting more than 10% of the workforce.

However, being self-employed doesn't mean missing out on the tax benefits associated with traditional workplace retirement plans. For self-employed individuals, two excellent options stand out: SEP IRAs and solo 401(k) plans. While both offer similar advantages, understanding their unique features can help you choose the best fit for your retirement savings strategy.

Maximizing Retirement Savings with SEP IRAs

SEP IRAs, or Simplified Employee Pension IRAs, were established by Congress in 1978 to extend the concept of IRAs to small businesses. Despite the term "pension," SEP IRAs function as tax-advantaged retirement savings accounts, allowing self-employed individuals and small business owners and their employees to benefit from simple, tax-efficient investment vehicles akin to personal IRAs.

One of the key advantages of SEP IRAs is their generous tax breaks. Unlike traditional or Roth IRAs, SEP IRAs offer substantially higher tax deductions, making them an attractive option for maximizing retirement savings. Additionally, SEP IRAs are relatively easy to set up and maintain, with minimal administrative overhead compared to traditional 401(k) plans.

Eligibility for SEP IRAs is broad, encompassing businesses of all sizes, including sole proprietorships, partnerships, and corporations. Contributions to SEP IRAs are made solely by the employer, with employees typically unable to make their own elective contributions. However, self-employed individuals can contribute directly to their SEP IRA as both employer and employee, allowing for substantial tax-deferred growth potential.

The Roth SEP IRA was created in 2023 as part of the SECURE Act 2.0 which provides the ability to make Roth contributions to a SEP IRA. While some guidance has been issued for this new advantage for the SEP IRA, additional information from the IRS is needed.

Unlocking the Potential of Solo 401(k) Plans

Solo 401(k) plans, also known as individual 401(k) or one-participant 401(k) plans, are tailored specifically for self-employed individuals. One of the key advantages of solo 401(k) plans is their enhanced contribution limits, which allow for greater annual contributions compared to SEP IRAs. Additionally, solo 401(k) plans offer the option for post-tax Roth contributions, providing additional flexibility in managing tax liabilities in retirement.

Eligibility for solo 401(k) plans is straightforward, with self-employed individuals and their spouses who work at least part-time being eligible to contribute. Solo 401(k) plans also allow for catch-up contributions for individuals aged 50 and older, further enhancing their appeal for older savers.

Choosing the Right Option for You

When deciding between a SEP IRA and a solo 401(k), several factors should be considered, including contribution limits, tax benefits, and eligibility requirements. While solo 401(k) plans provide higher contribution limits, SEP IRAs stand out for their simplicity, generous tax deductions, and the opportunity to diversify into alternative assets.

For self-employed individuals considering future expansion or hiring employees, SEP IRAs may offer a more flexible option that accommodates potential changes in business structure. On the other hand, solo 401(k) plans are ideal for those seeking to maximize their retirement savings potential and take advantage of higher contribution limits and additional features such as Roth contributions.

Preferred Trust: Your Partner in Retirement Planning

At Preferred Trust, we understand the importance of retirement planning and are committed to helping you achieve your financial goals. With our Self-Directed SEP IRAs, you can take control of your retirement savings and explore a world of investment opportunities beyond traditional asset classes.

Whether you're a self-employed entrepreneur or a small business owner, Preferred Trust's experienced team is here to support you every step of the way. Contact us today to learn more about our retirement savings options and start planning for a secure and prosperous future.