Objective information about financial planning, investments, and retirement plans

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)


One of the best tax deductions for a small business owner is funding a retirement plan.  Beyond any tax deduction you are saving for your own retirement.  As a fellow small business person, I know how hard you work.  You deserve a comfortable retirement.  If you don’t plan for your own retirement who will? Two popular small business retirement plans are the SEP-IRA and Solo 401(k).

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

SEP-IRA vs. Solo 401(k)

SEP-IRA Solo 401(k)
Who can contribute? Employer contributions only. Employer contributions and employee deferrals.
Employer contribution limits For 2016, up to 25% of the participant’s compensation or $53,000 whichever is less. Contributions are deductible as a business expense and are not required every year. For 2016, employer plus employee combined contribution limit is 25% of compensation or $53,000 ($59,000 if the employee is age 50 or older) whichever is higher. Contributions are deductible as a business expense and are not required every year.
Employee contribution limits A SEP-IRA only allows employer contributions. Employees can contribute to an IRA (Traditional, Roth, or Non-Deductible based upon their individual circumstances). $18,000 for 2016. An additional $6,000 for participants 50 and over. In no case can this exceed 100% of their compensation.
Eligibility Typically, employees must be allowed to participate if they are over age 21, earn at least $600 annually, and have worked for the same employer in at least three of the past five years. No age or income restrictions. Business owners, partners and spouses working in the business. Common-law employees are not eligible.

Note the Solo 401(k) is also referred to as an Individual 401(k).

  • 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. Consult with your tax professional to determine when your employee contributions must be made. 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 $18,000 ($24,000 if 50 or over) or 100% of your income for 2016 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 possible from Solo 401(k)s, but not with SEP-IRAs.
  • 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 contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

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Are Target Date Funds On Target for You?


Target Date Funds are a fixture in many 401(k) plans.  They are a good idea in concept, the execution has not always been terrific.

I recently wrote 5 Considerations for Investing in Target-Date Funds for the US News Smarter Investor Blog:

Target-date funds are a staple of many 401(k) plans. Most target-date funds are funds of mutual funds. The three largest firms in the target-date space are Fidelity, T. Rowe Price, and Vanguard with a combined market share of about 80 percent. All three firms use only their own funds as the underlying investments in their target-date fund offerings. Some other firms offer other formats, such as funds of exchange-traded funds, but the fund of mutual funds is still the most common structure.  

Here are a few considerations to think about when deciding whether to use a target-date fund option in your company’s retirement savings plan:  Click here to read the rest of the article.

Target date funds, like any investment, require thorough analysis to determine if they are the right choice for your personal situation.

Retirement plan sponsors also need to perform their due diligence on Target Date Funds before offering them as an option in their company’s plan.  All TDFs are not created equal.  There are wide variations in the equity percentages at the various target dates and in the various glide path philosophies.  This is not to say that any particular approach is right or wrong, but rather plan sponsors need to look at all aspects of a particular family of Target Date Funds to determine if they are the right choice for their plan, given the demographics of their participants.  In short, plan sponsors need to analyze their choice of Target Date Funds as diligently as they would any other investment option offered by the plan.

One size does not fit all here no matter what the Target Date Fund companies or 401(k) plan providers might want you to believe.

Please feel free to contact me with your questions.  

Check out an online service like Personal Capital  to manage all of your investment and retirement accounts all in one place. Please check out our Resources page for more tools and services that you might find useful. 

Its 2011, What Do I Do Now? – Retirement Plans


There have been a seemingly endless number of articles and cable news segments about what you should do financially in 2011.  Well its now 2011 and here are a few things I suggest on the retirement plan front.
401(k) Participants
·    Take a look at your account.  December was a good month for stocks; this may have caused your allocation to be too heavily weighted here.
·    Did your plan change its investment offerings?  Have you reviewed these new funds to see if they fit into your strategy?  Typically if a new fund is offered any money that is left in the old fund is automatically mapped over to the new fund. 
·    When you review and rebalance your 401(k)account do so in the context of your overall financial situation.  Consider outside investments such as old 401(k) plans, retirement plans, a spouse’s retirement plans, IRAs, taxable accounts, and the like.  Ideally do all of this in the context of your comprehensive financial plan.
·    If your employer offers access to direct, unbiased advice take advantage.  If it is free or at least inexpensive what do you have to lose?  Even if you are a do-it-yourselfer there is nothing wrong with a second opinion.
·    If your employer offers advice via an advisor who stands to benefit financially based on where and how you invest, I’d think twice.
·    Full disclosure, I am launching a service to provide fee-only, unbiased advice to 401(k) participants so I am hardly unbiased here.
·    While Target Date Funds might be the “easy” choice, I’m generally not a fan.  At the very least, look carefully at how the TDFs in your plan invest, how this allocation does or doesn’t fit with your goals and risk tolerance, and whether there is serious overlap with your outside investments.
·    Start or continue to fund a Solo 401(k).  If this plan fits your situation it can be an excellent vehicle to accumulate retirement assets to help reap the rewards of all of your hard work. 
·    Contributions to a Solo 401(k) can be made pre-tax or a Roth option can be used.
·    If you haven’t made a 2010 retirement plan contribution, consider funding a SEP IRA.  Contributions for 2010 can be made up to the date you file your return including extensions.
·    If your cash flow and income can support it, look into a Cash Balance Pension Plan.
·    Various retirement plans for solo and small businesses have different attributes.  Your best bet is to consult with your financial and/or tax advisor to see which plan(s) are best for your situation.  Whichever plan you choose, make sure to fund a retirement plan for yourself in 2011.  You work too hard not to.
To all readers of this blog and those of you who follow me on various social media platforms I wish you all a happy, healthy, and prosperous 2011.  If I can ever be of help in any way please feel free to contact me.

Make Pension Decisions Carefully


In the past, a retiree typically received a monthly pension check and Social Security benefits. Now, it’s not uncommon for a retiree to have a pension plan, a couple of 401(k) plans, some individual retirement accounts (IRAs), personal savings, possibly some deferred compensation, and maybe an annuity. Deciding how to handle all of those different income sources in the most advantageous manner is a daunting task. In many cases, decisions regarding pension plans are irrevocable, so proper choices are imperative. Before making those decisions, consider the following:

Prepare a list of all of your retirement assets, by type of plan. Indicate the expected monthly income as well as the earliest and latest date you can start taking benefits. Review the payment options available to see if some assets should be used before others. For instance, defined-benefit plans and deferred compensation plans generally require you to take benefits when you retire, whether you want the money or not. Other plans, such as 401(k)s and IRAs, allow you to start withdrawals between the ages of 59 1/2 and 70 1/2, providing flexibility regarding the amount withdrawn. Thus, if you can, it is typically advantageous to either leave that money in the plan or roll it over to an IRA to grow tax deferred until a later date. You must begin taking minimum distributions from traditional IRAs (not Roth IRAs), 401(k) plans (unless you are still working), and other qualified plans by the time you are 70 1/2.

Decide whether you want to take a lump-sum distribution or receive an annuity. This option is generally offered with 401(k) plans, profit-sharing plans, and some defined-contribution plans. Your decision should be based on the income tax ramifications of the different options, your personal needs, and your financial ability to handle the money.

If you opt for an annuity, you must decide among various payment options, including life only, which pays you a certain amount until your death; joint and survivor, which will also pay a certain amount to your spouse after your death; and life and period certain, which pays a certain amount for your life or a specific time period, whichever is longer. Your payments are generally taxed as ordinary income when received.

You may like the peace of mind that comes with annuities, since you are assured of a monthly income without having to worry about investment decisions. However, annuity amounts are typically fixed, so inflation can seriously erode the purchasing power of this income over the years.

A lump-sum distribution gives you the opportunity to invest your retirement funds. Thus, you receive the rewards of smart investment decisions, but you can also suffer from poor decisions. Since you own the funds, proceeds can be left to your heirs after death.

The tax treatment of a lump-sum distribution depends on how you handle the distribution. The least favorable alternative is to include all the proceeds in your taxable income in the current year, subjecting the proceeds to your top tax rate, and possibly the 10% tax penalty if you are under age 59 1/2.

As an alternative, any portion of your account balance in a qualified plan can be rolled over into an IRA within 60 days. This rollover defers the tax on the distribution and allows it to grow tax deferred until withdrawn. Keep in mind that if you take possession of the funds, your employer must withhold 20% of the proceeds, even if you plan to roll over the entire balance. You can avoid this provision by having your employer directly transfer the distribution to your IRA. If you are between the ages of 59 1/2 and 70 1/2, you can access the funds as you need them, penalty free, paying ordinary income taxes only as you withdraw funds.

Determine how to withdraw money from your plans. After going through this analysis, you can decide when to start taking distributions. These decisions will take into account your life expectancy, your tax situation, your current income needs, the expected inflation rate, and your expected rate of return on retirement assets. The calculations can quickly become very complex if you need to evaluate several different plans under several different payment scenarios. These calculations are so important for your retirement, consider seeking the help of a financial advisor to guide you through the process.