Simplified Employee Pension (SEP) IRAs are excellent retirement solutions for small businesses with just a few employees or for individual entrepreneurs.
They have high limits, allow employers to contribute to their employees’ retirement (a great recruiting and retention tool), and are easy to set up, plus they’re cost-effective.
What is unique about a SEP IRA is that ALL contributions are made by the employer, not the employee, thus exempting it from nondiscrimination and top-heavy testing. Plus, you’re also not required to file annual reports. These factors, when combined, keep administrative costs to a minimum and allow the owner to focus on growing their company.
Another significant benefit of SEP IRAs is the flexibility in employer-funded contributions. You can adjust them each year as you see fit based on the company’s financial situation. If your company is falling on rough times, you can decrease your contributions, and when business picks back up, you can increase them to previous levels – or possibly higher.
Contributions are tax-deductible for the employer, and employees enjoy tax-deferred growth on their investments, making SEP IRAs an attractive retirement plan option for both parties.
However, as an employer, you must contribute the same percentage of your employees’ compensation as you contribute for yourself. As always, there are maximum contribution limits.
You can contribute up to 25% of the employee’s total compensation or a maximum of $66,000 for the 2023 tax year, whichever is less. Unlike other retirement plans, there are no catch-up contributions.
The Savings Incentive Match Plan for Employees (SIMPLE) IRA is an ideal retirement plan option for businesses with 100 or fewer employees. Like a SEP IRA, the employer makes contributions, but unlike a SEP, the employee has the choice to contribute to their own retirement plan. Any employee contributions are tax-deferred, meaning an employee may stay in a lower tax bracket for the year.
As the business owner, you have two contribution choices. You can elect to match up to 3% of an employee’s salary. Alternatively, you have the option to make non-elective contributions of up to 2% of your employee’s salary, regardless of whether they contribute themselves. By doing so, SIMPLE IRA plans also qualify to abstain from nondiscrimination and top-heavy testing. Additionally, all employer contributions are immediately vested, unlike many company 401(K) plans.
One of the biggest downfalls of the SIMPLE IRA is the low contribution limits. In 2023, The annual contribution limits are $15,500 for those under 50 and $19,000 for those 50 and older, making them considerably lower than a 401(K).
Another valuable feature of the Solo 401(k) is the potential to take out loans. This allows participants to access their retirement funds in times of need without incurring penalties, providing additional flexibility and financial security. You can receive either $50,000 or 50% of your account value and must pay back the loan within five years.
In summary, the Solo 401(k) probably wins out as a retirement plan for individual entrepreneurs and freelancers. It has high contribution limits and allows both Roth and traditional contributions while providing asset protection from bankruptcy and creditors. Plus, you can take out loans, and your spouse can put into it as well!