In my experience, solo entrepreneurs are more familiar with the SEP-IRA than the Solo 401(k).
A SEP (simplified employee pension) plan allows employers to contribute to traditional IRAs (SEP-IRAs) set up for employees.
A business of any size, even self-employed, can establish a SEP. While both allow you to save $61,000 in 2022, there are some advantages to the Solo 401(k), also known as a one-participant 401k plan, that may make it the right choice for you.
#1 – Solo 401(k) plans allow you to include a Roth option
As SEP IRAs use traditional IRA accounts, no Roths are allowed. Your income may phase you out of a Roth IRA. If that’s the case, a Roth Solo 401k can get the Roth option back for you.
A Solo 401k is set up like a 401k you might be offered by an employer. Part of the money in the account is contributed by the employee, and part by the employer. In the Solo 401k, you as the sole proprietor are both the employee and employer. The employee portion can be set up as a Roth account.
Why might you want to include a Roth?
With a Roth account, your contributions are made post-tax. That means neither your savings nor your earnings will not be taxed at withdrawal. In addition, the contributions you make to yourself acting as an employer are deductible payroll expenses.
With a traditional account, on the other hand, both your savings and any investment earnings will be taxed when you withdraw the money. Your contributions are made with pre-tax dollars, so you are eligible for a tax deduction. Many people erroneously think there is a dollar-for-dollar reduction in taxes – not so. A traditional contribution simply reduces the amount of income subject to taxes.
#2 – If you’re over 50 years old, you can put more money into a Solo 401(k) than a SEP IRA
While both plans have statutory contribution limits of $61,000 in 2022, a solo 401k allows an additional $6,500 catch-up provision if you’re 50 years old or older. That savings boost can be a lifesaver if you’re trying to make up for years of not contributing to your retirement. You can choose to save your catch-up contribution as either traditional or Roth earnings.
#3 – You can take a loan from your Solo 401(k)
Have you ever been challenged with cash flow in your business? With a solo 401k, it’s possible for you to borrow up to $50,000 from your account, with no taxation or early withdrawal penalties. Generally, these loans must be repaid within 5 years in equal, periodic payments, with a reasonable interest rate applied
There’s no such borrowing option with a SEP IRA, where the money can only be accessed for retirement.
Roth accounts and plan loans are not standard features from every 401k provider. I work with providers that will help to customize a plan for you. Contact me at email@example.com to start your personalized exploration of the right retirement strategy for you.
Learn more about Kathleen Connors and connect with her on LinkedIn.