Introduction

As a self-employed individual or solo entrepreneur, planning for retirement can be a daunting task. However, with the right retirement savings vehicle, you can enjoy significant tax savings and secure your financial future. Two popular options are the Simplified Employee Pension (SEP) IRA and the Solo 401(k). In this article, we’ll explore the differences between these two plans and help you determine which one is best suited for your needs.

What Is a SEP IRA?

A SEP IRA is a retirement plan that can be established by any employer, including self-employed individuals. Authorized by Congress in 1978, SEP IRAs have been around much longer than Solo 401(k)s. Setting up a SEP IRA is straightforward, typically involving a bank, credit union, or investment brokerage.

With a SEP IRA, your investment choices may be somewhat limited to traditional options such as stocks or mutual funds. For 2023, self-employed individuals can contribute up to 25% of their net compensation or $66,000, whichever is less. SEP IRAs can also be offered as Roth IRAs, where taxes are paid on current income.

One key feature of SEP IRAs is that they do not offer catch-up contributions for individuals over 50, as they are fully funded by the employer. If your business expands and you hire employees, your SEP IRA can cover them, provided your guidelines align with IRS regulations.

Pros of SEP IRAs

• Easy setup
• Potentially larger contributions than traditional or Roth IRAs
• Low administrative and maintenance costs
• Can be set up as late as the tax due date (including extensions)

Cons of SEP IRAs

• No loans from saved funds
• No catch-up contributions
• Employee contributions not permitted

What Is a Solo 401(k)?

A Solo 401(k) is similar to a traditional 401(k) plan but is designed for one-person businesses or one person and a spouse. Created as part of the Economic Growth and Tax Reconciliation Relief Act of 2001, Solo 401(k)s can be either traditional (tax-deferred) or Roth.

To qualify for a Solo 401(k), you must have self-employment activity and no employees other than a spouse. Contributions can be made as both the employer and employee, up to a maximum of $66,000 for 2023. Additionally, individuals over 50 can make catch-up contributions.

Pros of Solo 401(k)s

• Higher contribution limits
• Flexible contributions
• Ability to contribute in the next calendar year to shelter income from taxes
• Option to borrow from the account

Cons of Solo 401(k)s

• More complicated and expensive setup
• Higher maintenance costs
• Cannot be used if additional employees are hired
• Required IRS reporting once the account reaches $250,000

Should You Choose a SEP IRA or a Solo 401(k)?

Many financial experts recommend a Solo 401(k) due to its higher contribution limits and flexibility. However, the administrative costs and tax reporting requirements can be greater than those for a SEP IRA. Additionally, if your business grows and you hire employees, a Solo 401(k) is no longer an option.

Ultimately, the best choice depends on your business structure and investment preferences. Consulting a financial planner can help you make an informed decision that aligns with your retirement goals.

The Bottom Line

As a self-employed individual, you are responsible for your own retirement savings. Both SEP IRAs and Solo 401(k)s offer tax-advantaged ways to save, but it’s essential to choose the right plan for your unique situation. Regardless of the option you select, developing a habit of saving for retirement is crucial for your long-term financial health.

At O1ne Mortgage, we understand the importance of securing your financial future. If you have any questions or need assistance with your mortgage needs, don’t hesitate to call us at 213-732-3074. Our team of experts is here to help you every step of the way.