If you own a small business or if you are self-employed, you may realize that your options are somewhat limited. You don’t have the convenience of an employer providing a retirement plan for you. It’s up to you to find a solution that suits your needs.
But which one is best for you? Let’s look at the key differences between the two.
Both options allow a maximum annual total contribution of $58,000 in 2021. But there are different restrictions on how you may contribute to each.
In 2020, the IRS limits your personal solo 401(k) contributions to $19,500. It also allows your business to make an employer contribution of up to 25% of your earned income for the year. The total of the two contributions cannot exceed $57,000 in 2020 or $58,000 in 2021. If you are 50 years old or older, you may put an additional $6,500 “catch-up” contribution into the plan.
Let’s say your W-2 wages in 2021 are $154,000. You could max out your employee contribution ($19,500). Your business could contribute up to an additional $38,500 (25% of your W-2 earnings). And if you’re 50 years old or older, you could put in another $6,500 as a catch-up contribution.
SEP-IRA stands for Simplified Employee Pension. It is an inexpensive vehicle for retirement savings and tax advantages for the right business model. From a tax-break standpoint, the SEP-IRA works very much like other retirement plans, except for the contribution limits. For the tax year 2021, the SEP-IRA contribution limit is $58,000 . It must be entirely in the form of an employer contribution, as opposed to an employee contribution: either up to 25% of wages or up to 20% of net adjusted self-employment income. If you earn at least $290,000 in 2021, you could max out your contribution to your SEP-IRA.
The deadline to open a Solo 401(k) is December 31 . But you don’t actually have to fund it until you file your taxes. That’s good news for procrastinators!
A SEP-IRA can be opened and funded up to the tax filing deadlines. If you’re running behind, you may also file for an extension to file for taxes. This would give you more time to open, save, and fund the account.
Do you plan on hiring employees someday? If so, you may want to restrict when and how they may participate in your retirement plan.
If you have a Solo 401(k), you may need to upgrade it to a regular 401(k) when you hire eligible employees. That’s because the Solo 401(k) only allows contributions for the business owner and spouse .
Unlike the Solo 401(k), you can continue your SEP-IRA if you hire employees . However, you will need to contribute on behalf of your employees to their SEP-IRA account.
It’s exciting to open your own business and be your own boss … and it’s a lot of work. Retirement planning is so important, but it may be the last thing on your mind.
Let us help! We can work with you to figure out your best option based on your goals and how your business is set up.