Christian Santos
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Christian Santos
Solo 401(k) Plans vs SEP Plans: Which Retirement Plan is Best for You.

Solo 401(k) Plans vs SEP Plans: Which Retirement Plan is Best for You.

Self-employed individuals often have an array of issues to worry about when running a business by themselves. There is often a solo focus on only worrying about profitability. Of course, this is important because one is unable to run a successful business without profitability. However, these individuals should not and cannot forget about their future both for themselves and, potentially, future employees. As such, every employer should be looking at adopting a retirement plan as a way to look out for their financial well-being in the future. Now, you may be thinking that it does not make sense to adopt a benefit plan as you’re a single employer company or even a company with a small number of employees. I’m here to tell you that line of thinking is incorrect and there are significant benefits for a self-employed individual to adopt one. Now, with a different array of choice to select from, what is the best plan to choose. For briefness, we will focus on two of the most popular choices for self-employed persons, Solo 401(k) Plans and SEP Plans.

One of retirement plan that may be attractive to adopt is the Solo 401(k) plan. The Solo 401(k) plan states that the only participant that can enter into the plan is the business owner along with their spouse IF they work for the company. However, no other employees are allowed to enter. This plan is similar to regular 401(k)s and must abide by IRS regulations. In 2022, the self-employed employee can contribute elective contribution up to $20,500, or $27,000 if they are eligible for catch up contributions. Unlike some traditional plans that have limitations on the percentage of salary that can be elected to be deducted, the self-employed employee – owner can contribute 100% of their salary into the plan. Self-employed - owners also have the added benefit of an employer contribution (not to be mistaken for the elective deferral) and the owner acting as the company can contribute up to 25% of the employee-owner’s compensation as long as the self-employed employee-owner has not surpassed the total contributions limit of $61,000 for 2022 with both the elective and employer contribution. The plan also needs to be established by the end of the tax year to count towards the return.

The other retirement plan up for discussion is the Simplified Employee Pension (SEP) Plan.  SEP Individual Retirement Account (IRAs) is another self-employed retirement plan that allows the self-employed owner to have a retirement plan. This plan is different from a Solo 401(k) plan in a few ways: there is no elective deferral, the plan only allows for pre-tax contributions, and no loans are available with this plan. The biggest difference is that the company can make contributions to their employees along with the business owner. As such, the plan is essentially a profit-sharing plan where the employer contribution can be up to 25% of the employee’s pay, or $61,000 in 2022, whichever is less. Nonetheless, there are some rules to this. Employer contributions must be the same percentage across all employees, but the business owner has discretion over what that percentage will be. In this plan, contributions are immediately vested, and investment decisions are made by the employees.

Which is better for you? It depends on your individual situation. If you’re a self-employed owner with no other employees beside your spouse, it may be beneficial to adopt a Solo 401(k) plan. The reason is that even if the company struggles to make a profit, you will still be able to contribute elective deferrals into the plan. This, at the very least, allows you to grow your retirement fund instead of completely missing years where the company simply cannot contribute. This is especially important if you’re over the age of 50 and you can contribute an additional amount related to catch up. The other benefit is that unlike an SEP plan, you are not limited to pre-tax contributions, but have the option for post-tax contributions.  In contrast, a SEP plan may be more beneficial for you if you want to establish benefits to attract employees while the company is still small in size. The company’s ability to decide the percentage of the employer contribution give you flexibility year to year, but still allow you (the self-employed owner) to contribute to your own retirement. There is also less maintenance and fees to deal with when it comes to such a SEP plan.

Overall, no matter the plan that is chosen, self-employed individuals should seek to adopt some kind of retirement plan as it is important for their future financial well-being. If you have any further questions about any of these retirement plan and want more detail about some of the tax benefits that comes with adopting such plans, please contact us at ADKF. We would be happy to help and get you the expertise you need to ensure that we are providing you the proper service.


ADKF
is the largest, locally owned public accounting firm in San Antonio, Texas, with branch offices in Boerne and New Braunfels. We have been serving our community since 1991. We are a full-service CPA firm dedicated to providing a broad range of tax, audit, bookkeeping, tax controversy, and consulting services with superior customer service to help our clients meet their goals and objectives. Please click here to set an appointment with us.

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