SEP IRA V/S. Solo 401(k): Which Should You Choose?
The key to significant retirement savings is to start early and invest well. Remember, the more money you can put away in good growth funds, the larger your retirement nest egg will grow. Therefore, you should consider several retirement plans, including the SEP IRA and the solo 401(k) retirement plans.
To educate you about these two retirement plans, M-E Accounting & Tax Services, Inc. has weighed up the pros and cons and highlighted which may be best for you. Let’s start with the similarities between the two options.
The SEP IRA and the solo 401(k) retirement plans:
• create tax deductions for the money you invest in the plans
• grows tax-deferred inside the plans
• suffers taxes only when you take the money out of the plans
The Advantages of SIMPLE-IRA
When your business produces only a modest annual income, the SIMPLE-IRA arrangement can permit much healthier deductible yearly contributions to your account.
For example, Suppose you invest $1,000 a month in your retirement, are in the forty percent tax bracket (combined federal and state), and earn 10 percent on your investments. In that case, you will have approximately $1.58 million in your corpus after-tax spendable cash at the end of thirty years.
It comes from:
• $1.2 million in after-tax cash from the retirement plan ($2 million gross less 40 percent in taxes, we’re taking the entire amount out of the plan in this example).
• $380,000 in the side fund (created by investing the $400 of monthly tax savings, $1,000 deduction x 40 percent).
Flexibility is Good!
An advantage of SIMPLE-IRA is that elective deferral contributions are entirely discretionary. So, if you decide not to make an elective deferral contribution for the year, you need not make any employer-matching contribution. So, you can limit contributions to minimal amounts or even nothing in years when cash is tight! Finally, with a SIMPLE-IRA, there is no requirement to file annual reports with the federal government.
The disadvantages of SIMPLE-IRA
The SIMPLE-IRA is not the best choice if your business produces a healthy annual self-employment income or a healthy annual corporate salary for you. In that scenario, other plans, such as a SEP, solo 401(k) plan, or defined benefit pension plan, can permit more significant annual deductible contributions to your account.
You must also establish your SIMPLE-IRA by no later than October 1, for which the initial deductible contribution will get made. For example, you must set up your SIMPLE-IRA by October 1, 2022, to make a deductible contribution for the 2022 tax year.
Please Note: The SECURE Act modification allows qualified plans to set themselves up retroactively for the prior year and doesn’t apply to the SIMPLE-IRA.
Making the Right Decision
In this article, we tried to compare the SEP IRA with the solo 401(k) to ascertain which one was better for a business owner with no employees other than him or herself (if incorporated). Before we offer our perspective, we want to share the following insights:
• A SEP IRA is typically easier and cheaper to set up than a solo 401(k).
• With the solo 401(k), you have to file form 5500 EZ once your plan assets exceed $250,000.
• In most cases, the owner of a one-person business can save more money for retirement with the solo 401(k) than with the SEP IRA, as the solo 401(k) allows both the employee elective deferral and the employer contribution.
A Professional Perspective
When your business generates a modest amount of self-employment income or salary from your corporation, and there are no other employees who must be covered, the SIMPLE-IRA is probably the best choice. The primary reason is that it offers the opportunity to make more considerable annual deductible contributions.
The contribution is even more significant if you’re fifty or older, as you can make additional elective deferral catch-up contributions. Keep this in mind: SIMPLE-IRAs are simple, and simple is good.
Get In touch with us today!
With many years of experience, M-E Accounting & Tax Services, Inc. can help you make sense of your money and plan for retirement. Our services include accounting, bookkeeping, business consultation, payroll services, and tax preparation.
We offer tax preparation services for individuals and small businesses across Cocoa Beach, Cape Canaveral, Merritt Island, Rockledge, Patrick Space Force Base, Titusville, Port St. John, Cocoa West, and Satellite Beach.
To learn more about our services, please click here. If you have any accounting questions, please call (321) 613-3839 or email MotazE@metaxservices.net.