This time of year many small business owners are looking for additional tax deductions. One of the best deductions is funding a retirement plan. Beyond any tax deduction you are saving for your retirement. As a fellow small business person, I know how hard you work. You deserve a comfortable retirement. Two popular plans are the SEP-IRA and Solo 401(k).
A comparison of the main features of the two plans
|Who can contribute?||Employer contributions only||Employer contributions and employee deferrals|
|Employer contribution limits||For 2013, up to 25% of the participant’s compensation or $51,000 ($50,000 for 2012), whichever is less.Contributions are deductible as a business expense and are not required every year.||For 2013, employer plus employee contribution limit is $51,000 ($56,500 if the employee is age 50 or older). For 2012 the limits are $50,000 and $55,500.Contributions are deductible as a business expense and are not required every year.|
|Employee contribution limits||Technically there are no employee contribution limits, but employees can contribute to an IRA (Traditional, Roth, or Non-Deductible based upon their individual circumstances).||$17,000 for 2012 and $17,500 for 2013. An additional $5,500 for participants 50 and over. In no case can this exceed 100% of compensation.|
|Eligibility||Typically, employees must be allowed to participate if they are over age 21, earn at least $550 annually, and have worked for the same employer in at least three of the past five years. Check with your custodian for specific eligibility requirements.||No age or income restrictions, generally.|
Note the Solo 401(k) is also referred to as an Individual 401(k).
A few points to consider
- While a SEP-IRA can be used with employees in reality this can become an expensive proposition as you will need to contribute the same percentage for your employees as you defer for yourself. I generally consider this a plan for the self-employed.
- Both plans allow for contributions up your tax filing date, including extensions for the prior tax year. The Solo 401(k) plan must be established by the end of the calendar year.
- Note that the SEP-IRA contribution is calculated as a percentage of compensation. If your compensation is variable so will the amount that you can contribute to plan year-to year. Even if you have the cash to do so, your contribution will be limited by your income for a given year.
- By contrast you can defer the lesser of $17,500 ($23,000 if 50 or over) or 100% of your income for 2013 into a Solo 401(k) plus the profit sharing contribution. This might be the better alternative for those with plenty of cash and a variable income.
- Loans are available from Solo 401(k)s, but not with SEP IRAs.
- A Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP IRA.
- Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the level of annual government paperwork increases a bit.
- Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
- Investment options for both plans generally run the full gamut of typical investment options available at your custodian such as mutual funds, individual stocks, ETFs, bonds, closed-end funds, etc. There are some statutory restrictions so check with your custodian.
Both plans can offer a great way for you to save for retirement and to realize some tax savings in the process. Whether you go this route or with some other option I urge to start saving for your retirement today.
Please check out Small Business Retirement Plans – SEP-IRA vs. Solo 401(k) 2015 Update which is an updated version of this post.
Please feel free to contact me with your questions.
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