This is an update of one of the most popular posts on this blog Small Business Retirement Plans – SEP-IRA vs. Solo 401(k) revised to reflect contribution limits for 2015. As a business owner it is up to you to save for your own retirement. Both of these vehicles can be good choices depending upon your situation. You work hard and deserve a solid retirement. Please start a retirement plan for yourself and your family, or if you have one in place make sure you fund it.
A comparison of the main features of the two plans – 2015 Update
|SEP-IRA *||Solo 401(k)|
|Who can contribute?||Employer contributions only.||Employer contributions and employee deferrals.|
|Employer contribution limits||For 2015, up to 25% of the participant’s compensation or $53,000, whichever is lower. Contributions are deductible as a business expense and are not required every year.||For 2015, employer plus employee contribution limit is $53,000 ($59,000 if the employee is age 50 or older). Contributions are deductible as a business expense and are not required every year.|
|Employee contribution limits||The maximum combined employee contribution to a SEP-IRA and/or a Roth or Traditional IRA is $5,500 ($6,500 for those 50 or over).||$18,000 for 2015. Plus an additional $6,000 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 $600 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 SEP-IRA can be started up for the prior tax year until the date that your tax return is due including extensions. Likewise contributions for the prior tax year can be made up until the date your extension is due. For those who have not made a contribution to a retirement plan for the 2014 tax year this might be an option as of the date of this article.
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.
- The Solo 401(k) Plan is also for the self-employed with no employees other than a spouse or business partner.
- Both plans allow for employer 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 $18,000 ($24,000 if 50 or over) or 100% of your income for 2015 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 use some other option better suited to your situation I urge you to start saving for your retirement today. Talk with your financial or tax advisor to determine the best retirement plan for your situation.
Please feel free to contact me with your questions, comments and suggestions for future topics you’d like to see covered here at The Chicago Financial Planner.