Plans for Employers
As a business owner, managing your company finances is one of your most important priorities. From allocating capital for repairs to looking over paperwork for purchases, you know how to navigate to get your business where you want it to be. So why not do that for your retirement? Business owners have access to two powerful retirement savings tools: The Solo 401(k) and the Simplified Employee Pension Plan IRA (SEP IRA).
Briefly, the main difference between a Solo 401(k) and SEP is who can contribute to each, thus resulting in slightly different rules around each of them. As the name suggests, the Solo 401k can only be created for self-employed individuals with no employees. This contrasts with SEP IRAs which can be established by employers with (or without) W2 employees. Thus, the SEP can be more widely utilized. They do also have slight differences in contributions limits, uniformity, and tax types.
Exploring Solo 401(k)s
Starting first with the Solo 401k, many self-employed individuals like to take advantage of what this retirement plan has to offer. This is because of the very generous contribution limits set, totaling to a potential of $66,000 a year being invested into a Solo 401k ($73,500 if you are over the age of 50). These contribution limits come from two sources, the first is as an employee of the company, where you can contribute $22,500 per year (2023). The second source is as the employer of the company, wherein you can contribute up to 25% of the business’s income, up to a total combined value of $66,000 (2023).
Solo 401k’s also allow a level of flexibility to the extent that if, for example, your business is having a bad year, you can dial back how much you contribute. This flexibility extends to both taking a loan from your 401k and no debt leverage taxes. This means you can take the smaller of 50% of the value of your Solo 401(k) or $50,000 out as a loan, and you do not have to pay the UDFI tax. Lastly, there are both Traditional and Roth tax types for Solo 401(k)s.
Reviewing SEP IRA
Moving on to SEP IRAs, they are a great option for business owners with a small number of employees. SEP IRAs allow you to contribute up to 25% of the business’ income, up to $66,000 annually, and function exactly like a Traditional IRA with required minimum distributions and tax-deductible contributions (2023). There are no catch-up contributions for people over the age of 50 with SEP IRAs.
The uniformity within SEP IRAs is important to recognize. SEP IRAs require everyone under the SEP to be treated equally. This means the employer must contribute equally for all employees. This is because contributions can only be made through the employer, employees are not able to contribute to SEP IRAs. For example, if an employer contributes $10,000 to their SEP IRA, they must contribute the same amount to everyone within the plan. There are no Roth tax type SEP IRAs.
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