sep ira vs ira

sep ira vs ira

by Brian Nelson

Building a retirement nest egg requires understanding your options.

Making decisions on how to invest for retirement is never easy, given the number and complexity of retirement account options. The types of IRA accounts alone can be overwhelming. Fortunately, a little understanding goes a long way when it comes to these types of accounts. The differences between a traditional IRA and a SEP-IRA involve only a few key concepts.

Individual Retirement Arrangements, or IRAs, are a special type of tax-advantaged account used to save and invest for retirement. IRAs of all types are regulated by the IRS, which establishes rules regarding how IRA accounts may be used, and by whom.

A traditional IRA is a type of personal IRA. Along with the Roth IRA, personal IRA accounts are established, managed and maintained by an individual taxpayer. All benefits and responsibilities of the IRA go directly to the account owner.

Certain types of IRAs have been established to allow small businesses to offer retirement plans to their employers. Along with the SIMPLE-IRA, the SEP-IRA is a small-business retirement plan. These plans must be established by a business or employer. They are not available to nonbusiness entities.

Qualified taxpayers may get a tax deduction for contributions to a traditional IRA. But only the employer may contribute to a SEP-IRA account. In this case, the employer gets a business tax deduction for contributions to the employee's SEP-IRA account. These contributions do not count toward the employee's maximum IRA contribution. In other ways, the SEP-IRA is the same as a traditional IRA.

SEP IRA Vs SIMPLE IRA - Quick Reference Guide-- 2012

Last Updated September 12, 2012

Small business owners, who like the simplicity and low administrative costs associated with simplified employee pension (SEP) IRAs and savings incentive match plan for employees of small employers(SIMPLE) IRA plans, often find it hard to choose between the two. An understanding of the features and benefits of these plans can help to make the choice easier. This Appleby Quick Reference Guide provides a comparison of some of the key features and benefits of these plans.

Roth IRA vs. SEP if Self-Employed

Your choice of retirement plan depends upon your situation.

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There is no perfect retirement account, even if you're self-employed. While small business owners enjoy a little more flexibility when they determine their retirement options, calculating whether to invest in an Roth individual retirement arrangement or a simplified employee pension plan IRA -- or both -- is a matter of how each fits into your personal retirement plan preferences.

Self-employed investors may use a Roth IRA to help fund part of their retirement. The only requirements are that you -- and/or your spouse -- have earned income equal to your contributions, but your adjusted gross income must be under $125,000 if single or $183,000 if married. Rules for Roth contributions are the same for spouses who work or don’t work. If you’re married and file separately, however, spouses who report more than $10,000 in income can’t contribute. Roth IRAs allow only after-tax contributions rather than tax-deductible contributions as for traditional IRAs. As of 2012, single individuals may contribute $5,000 each year, or $6,000 if you’re 50 or older; those amounts double if you file a joint return.

Although you pay income taxes on funds you deposit in an Roth IRA, all investment income you receive is virtually tax-free. Because you paid income taxes on the contributions before you made them, distributions from a Roth aren’t subject to income taxes again. As with traditional IRAs, you face a 10 percent penalty if you receive a distribution before you turn 59 1/2 or sooner than five years after you opened your Roth IRA. The IRS allows penalty-free early distributions under some circumstances; these include up to $10,000 to purchase your first home or distributions you take if you become disabled and can't work.

SEP Contribution and Distribution Basics

If you are self-employed and have no other employees or high employee turnover, a SEP IRA may be a good solution for your retirement needs. A SEP allows you to make pretax contributions similar to a traditional IRA, which reduces your taxable income rather than after-tax contributions like a Roth IRA. Another advantage over a Roth IRA is the higher contribution limit. You may contribute as much as 25 percent of your annual income, up to $50,000 cap, in 2012. Because these contributions are made on a pretax basis, however, once you reach retirement age -- at least 59 1/2 -- you pay income tax on all distributions.

Although the SEP contribution limits are much higher than those of Roth IRAs, they come with a major caveat: You have to contribute the same percentage of wages for every eligible employee in your company. Although you may set more lenient requirements, the Internal Revenue Service requires that any employee who is over 21, earned $550 in wages from you during the year and worked at least three of the five prior years, receives the same contribution percentage as you. Thus, SEP IRAs are costly for business owners with large staffs.

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Wilhelm Schnotz has worked as a freelance writer since 1998, covering arts and entertainment, culture and financial stories for a variety of consumer publications. His work has appeared in dozens of print titles, including "TV Guide" and "The Dallas Observer." Schnotz holds a Bachelor of Arts in journalism from Colorado State University.

Retirement Plan Comparison: 401(k) vs. Solo 401(k) vs. Simple IRA vs. SEP IRA

Saving for retirement has transitioned from the historical defined benefit pension plan where your employer took care of the future with a nice pension plan, to ‘you’re on your own’. This article will guide you in the quest for a secure retirement. Today, unlike during the last century, retirement rests firmly upon your shoulders. It’s unlikely that Social Security will cover all of your future retirement expenses. Thus, it’s up to you to figure out which plan or plans will be the best home for your precious retirement savings dollars.

Before we get into the meat of the article, let’s look at two commonalities among all of the retirement accounts:

  1. We are discussing types of accounts, not specific kinds of investments.
  2. While in the account, your money grows tax-free.

Further, it’s useful to understand that you might place your money in the same mutual fund, whether it's in a 401(k), Simple IRA or a SEP IRA.

This article will clear up the confusion about several retirement plan options. In the first section, we’ll provide an overview of each retirement account option. You’ll learn that some of these retirement accounts are for employees, some are for employers, and there are accounts that pertain to both employers and employees. The chart will provide a clear comparison of the features of the 401(k)/403(b), Solo 401(k), Simple IRA and SEP IRA accounts.

A 401(k), which is widely used across the United States, is a retirement savings account created for you by your employer. You transfer money from your paycheck into the retirement account. The investment options within the plan are selected by your employer and from that predetermined selection, you may choose the funds for your individual 401(k) account. You’ll likely choose from among stock, bond, and combination stock and bond mutual funds. Many companies often offer what's called a 401(k) match, in which they contribute additional money on top of your own contributions as an employee benefit and incentive for employees to increase their own contributions.

The beauty of the 401(k) account is that the money transferred into the account, is removed from your taxable income and isn’t taxed until withdrawn in retirement. Thus, if you make $60,000 per year and contribute $15,000 to your retirement account, you’ll only pay federal income tax on $45,000. And once in the account, the funds grow tax-free as well.

There's a similar type of retirement account called a 403(b), which is often used by schools, nonprofits, and religious organizations. The major difference between the 401(k) and 403(b) accounts is the type of employer. A 401(k) can be offered by any public or private firm and is much more common. A 403(b), also known as a tax-sheltered annuity (TSA) plan, is a retirement account for certain tax-exempt organizations. The 403(b) investment options may include annuity contracts as well as mutual funds.

The Solo 401(k) for a Small Business Without Employees

If you’re an entrepreneurial business person without employees, then you may create a 401(k) plan for you and your spouse. The solo 401(k) plan follows the same rules as the employer sponsored 401(k) including contribution limits.

Simple IRA for Small Businesses

The Simple IRA was created to give small employers with fewer than 100 employees and $5,000 or more in compensation a straightforward way to contribute to their employees and their own retirements. Employees can elect to contribute to their Simple IRA and the employer is required to make either matching or nonelective contributions to the IRA retirement account. Similar to the other retirement plan options, all employee contributions are made pre-tax, in other words, the funds are transferred from the worker’s salary to the accounts before income taxes are calculated. Thus, by contributing to these types of retirement plans, not only are employees growing their retirement monies, they are also reducing their current income taxes.

Any size business is eligible to set up a SEP IRA for their employees. This easy-to-administer plan is funded solely with employer contributions and is similar to a traditional IRA account. Further, employers can contribute up to 25% of the employee’s contribution into their SEP IRA account with a $53,000 cap for 2016.

401(k) vs. Solo 401(k) vs. Simple IRA vs. SEP IRA

So which type of retirement plan makes the most sense for you? The following chart lays out the details of each of the retirement plans.

SEP IRA vs. Solo 401(k) – Which Is Better for You?

Self-employment has many perks. But it also comes with a lot of responsibilities — not the least of which is saving for your own retirement. When you work for an employer, you can usually count on there being a 401(k) plan or something similar already in place that you can contribute to. However, when you work for yourself, it’s a different story. Since you are your own boss, you are responsible for both starting your own plan and funding it.

Luckily, there are products on the market that can help you out. Here are two retirement plan options worth considering if you’re self-employed or a business owner.

A simplified employee plan (SEP) IRA is a type of IRA that works well for the self-employed or the small business owner. If you have employees, they can make contributions. But this can be an expensive proposition, since contributions for employees must match the percentage of the salary that the owner makes for themselves. So if you’ve got employees, another plan such as a 401(k) or a Simple IRA might be a better choice. (If you’re interested in setting up a 401(k) plan for your employees, check out services such as America’s Best 401k, which can help you provide your employees with a quality, low-cost plan.)

Some features of the SEP IRA include:

  • Contributions are made entirely by the business. There are no employee contributions.
  • Contributions are a business expense.
  • Contributions can be made up to 25% of compensation. For those who are sole proprietors, this might actually end up as 20% of self-employment income due to the way the calculation flows through Schedule C.
  • The maximum contribution for calendar year 2017 is $55,000.
  • SEP IRA accounts are available through most major custodians.
  • Investment choices are generally the same as for a regular IRA account.
  • A SEP IRA account can be opened and funded up until the date your tax return is filed, including extensions for the prior year.

However, you might want to take note of these limitations:

  • There are no loans available from a SEP IRA.
  • There is no Roth option available.

(Note: If you choose to invest with a SEP IRA, one of our top-ranked robo advisors, Betterment, is currently offering up to 12 months completely free with a special promotion.)

A solo 401(k), also called an “individual 401(k),” is a great solution for the self-employed as well. The solo 401(k) offers both employee and employer contributions. Most major custodians offer a solo 401(k). However, the rules may differ a bit from custodian to custodian.

Some features of the solo 401(k):

  • The plan is available only to business owners, spouses involved in the business, and partners. Other employees are not allowed to participate.
  • Employee salary deferrals are allowed, as well as employer profit sharing contributions.
  • The limits for employee deferrals are the same as for a 401(k) plan offered by an employer. The limit is $18,500 annually with a $6,000 catch-up for those who are 50 or over at any point during the year.
  • The maximum combined employee contributions plus employer profit sharing contributions cannot exceed $55,000 for 2017, with an extra $6,000 up to $61,000 for those who are 50 or over during the year.
  • Most major custodians support solo 401(k)s. Investment options are generally the same as available to other investors in brokerage or IRA accounts. However, some custodians may have restrictions. So it is best check before opening your account.
  • In order to take a deduction for the current tax year, the account must be opened by Dec. 31 of that year.
  • Both salary deferral and employer profit sharing contributions can generally be made until the date your return is filed, including extensions. This can vary for the salary deferral based on your business’s structure. It’s best to check with a knowledgeable tax professional here.
  • Loans and a Roth option are permitted. But you should check the rules for the plan offered by your custodian to confirm this.
  • There are minimal governmental filing requirements that generally don’t kick in until the plan balance exceeds $150,000.

(Note: Here at Investor Junkie, we’ve reviewed several online services that can help manage your solo 401(k), including SaveDay and Firstrade.)

While there are some similarities, there are some differences too. And as with most things in the world of investing, there’s not a one-size-fits-all solution.

The SEP IRA will be the easiest to open. A plan can be started up to the date that your return for the prior year is filed, including extensions. However, while the solo 401(k) might involve a bit more paperwork to open, the difference here is small.

There’s a bigger difference that’s worth taking into consideration.

In years when your income may be lower than usual, the “percentage of compensation” method used for calculating SEP IRA contributions will result in a lower contribution amount for you even if you have the cash to make a larger contribution. In addition, the SEP IRA doesn’t allow for catch-up contributions.

With a solo 401(k), as long as your compensation exceeds the $18,000/$24,000 annual limits, you can contribute the full amount. So if you’re really looking to save for your retirement big-time, a solo 401(k) might be your best bet.

When you’re self-employed, it can be easy to overlook investing in a retirement plan. (After all, you don’t have an HR department sending you reminder emails about signing up for an employer-sponsored program.) But there’s no reason why you can’t be saving too. No matter which plan you choose — whether it’s a solo 401(k) or SEP IRA or another kind of retirement savings program — make sure to do your due diligence. Talk with a trusted financial expert, and weigh your choices when it comes to choosing a custodian.

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