SEP IRA vs. Solo 401(k) – Which Is Better for You?

Daniel Penzing
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What's in this Article?

A Solo 401(k) and SEP IRA? What are they and what's the difference? If you're thinking about starting a business, this article is for you. Here are the differences between a Solo 401(k) and a SEP IRA and how you can use one to reduce your taxes now.

Do you work for yourself?… Do you have a fledgling business?… Do you want to reduce a large tax liability in the future? If so, you're not alone. Many Americans are looking to save for their retirement and reduce the tax liability that they owe in the future. For those with a taxable income or self-employment income, you have extra options to save.

The most common type of retirement plan available to an individual is a retirement plan known as a SEP IRA. More and more individuals are looking for ways to save money for their future and reduce their tax liability. If this describes you, you might want to learn more about SEP IRAs because they can offer you a way to save some money for your future while reducing your current income tax liability.

The most common type of retirement plan available to an individual is a retirement plan known as a SEP IRA.

SEP IRA is an acronym for Simplified Employee Pension Individual Retirement Account. SEP IRAs are a kind of qualified retirement plan that is intended to cover an individual, such as a self-employed business owner.

Introduction to Self-Employment Retirement Plans

What Is SEP IRA?

_____Provides tax-deferred growth of retirement savings.

_____Simplified paperwork and low fees.

_____Higher contribution limits than Solo 401(k).

What Is Solo 401(k)?

As self-employed individuals, small business owners have certain unique and often quite complicated tax issues that you don’t have to worry about if you work for a large corporation. One of the most common tax issues for small business owners is how to get profits from the business tax-free, early with a SEP or solo 401(k) plan.

So Which Plan Is Best for You?

The SEP IRA and solo 401(k) plans are both retirement plans that are available to the self-employed. They each offer certain tax benefits, leaving it up to you to determine the best option, especially regarding your tax situation.

While both plans allow you to take funds from your business to benefit your personal retirement account, how you distribute those funds is definitely different with the two plans.

SEP IRA

A SEP IRA is an individual retirement account. It’s very similar to conventional IRAs, except that it’s not contributory and can’t be owned by anyone but the business owner (i.e. you). You can funnel both pre-tax and after-tax funds into it during tax years.

Unlike other retirement plans, the SEP IRA allows you to take funds out of your account right away. You can also start contributing early and convert it to a traditional IRA later if you choose.

If you contribute before the end of the tax year, you can take money out later, up to April 15 of the following year, and it will be subjected to taxes and penalties. If you don’t use it by April 15, the account continues to grow tax-deferred.

Conclusion

If you are over 50, a solo 401(k) might be a better option than a SEP IRA.

If you are self-employed, the Solo 401(k) will provide you with a lot more flexibility than a SEP IRA.

The Solo 401(k) is also a better choice for the self-employed because it is easier to administer than the SEP IRA, especially for someone who is unfamiliar with handling financial matters.

If you are an independent contractor, the Solo 401(k) is a suitable alternative to a SEP IRA, especially since you can also use the Solo 401(k) if you have multiple companies.

However, if you are not self-employed and have employees, the SEP IRA is better.

The SEP IRA is also a much better choice for the non-self-employed because it can be established easier than the Solo 401(k).

You will have to either work out of your home or have a separate office. You will also have to pay for health benefits for yourself.