SEP IRA versus Self-Employed 401(k)

I am trying to get a handle on the best option for my husband's business retirement needs.  He is self-employed and we need to start some type of retirement savings for him.  I thought I was settled on a SEP IRA.  But then found Self-Employed 401(k) and am a bit unsure which direction to go.  We are both employed by his business so it seems the self-employed 401(k) may be the way to go.  It appears the self-employed 401(k) acts like a traditional 401(k) but can also allow for profit sharing deferment as well, so we could go beyond the max 401(k) contribution.  Anyone have any experience our insights on this?  Thank you!

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  • If the company has no employees other than owners and their spouses, then a one participant 401k (it can be marketed under many different names) is the way to go.

    The contribution rules are dependent on net business income amounts to determine limits as well as whether the company is an S Corp or Schedule C. But there is an opportunity to contribute more as an employee and employer than with a SEP-IRA.

     

    In addition, if your income is high enough that you can no longer make deductible Traditional IRA contributions or normal Roth IRA contributions, a SEP-IRA will get in the way of doing a backdoor Roth.

     

    As for which one participant 401k provider to go with, it depends on your needs, and there are pros and cons with most of them. I moved from Vanguard to Fidelity because I needed the ability to roll in a traditional IRA, which Vanguard doesn't offer.

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  • Honestly, I think this decision is important enough that you should consult a professional financial advisor. The information online can be confusing if you're not familiar with all the terms and how exactly they work together when it comes to saving now and disbursement later - and self-employment makes it even more confusing. I highly recommend that you ask for some professional advice - if you're part of a credit union, they may offer this for free, but if you can't get it for free, your future is well worth the fee for a 1 hour consult. Good luck!

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      • nolesrule
      • YNAB4 Evangelist
      • nolesrule
      • 2 yrs ago
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      You don't need a financial advisor for this. I would recommend asking your question on Bogleheads.org . There are enough experts there to give you the advice you need. A lot of tax CPAs and financial advisors don't understand this subject well enough to be of any value.

      If you want to contribute more than the SEP-IRA limit, a one participant 401k will always be your best bet.

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    • nolesrule I’m inclined to agree about not needing an advisor and I hope that serves me well.  I appreciate your input.  I’ve also asked this in the Choose FI group on Facebook and am thinking about going with the 401k.  I’ve been reading a ton and I think that seems like the way to go.  I’ll check out Bogleheads too.   Am actually in the midst of reading The Bogleheads Guide to Investing and just finished Simple Path to Wealth.  There is a considerable amount of knowledge out there to be had but I always value input from people on the same path.  Thanks!

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  • The easiest and quickest to setup is the SIMPLE IRA.  I recommend people start there (that don't have anything) because in the time you putz around researching, you can have the account paperwork out the door and get started.

    The Solo-401K let's you put away more than the SEP, but is often higher fee.  Between the two of you, you can do $25K in the SIMPLE.  If that's not enough, then you can do the SEP.  If the SEP isn't enough, do the Solo-401K.  The fees are generally higher on the more complex plans, which is why I love the Schwab SIMPLE for any time we don't have employer retirement plans.

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      • nolesrule
      • YNAB4 Evangelist
      • nolesrule
      • 2 yrs ago
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      Alex_H I've set up one participant 401ks at both Vanguard (twice) and Fidelity. They were both very easy to set up and contribute to. 5500EZ paperwork is not difficult once your plan  balance reaches that threshold or you are permanently closing the plan (I did that when I moved from a Florida S-corp to NJ LLC).

      I would not go with a SIMPLE or SEP IRA, for any number of reasons including lower contribution limits and ability to do a backdoor Roth if your income gets to that point. Also, if you open a SIMPLE or SEP and then realize you wanted to contribute more, you are stuck, because you cannot switch to and contribute to a one participant 401k in the same year as you have made contributions to a SIMPLE or SEP IRA.

      In all, the one participant 401k provides much more flexibility. So you might as well start with the right plan up front rather than having to switch plan types later.

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      • Alex_H
      • Alex_H
      • 2 yrs ago
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      nolesrule And my disagreement is that I think that most people asking this question are going to choose to optimized the Solo-401K, and end up doing nothing.  Movement tends to beat non-movement.  I think that there are bigger psychological hurdles to the more complex plans.  I realize you've done them without trouble, but you're not a person posting "I've never saved a penny, where do I start?"  -- the likelihood of them going from 0 -> more than $12,500 is pretty close to 0%.

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      • Alex_H
      • Alex_H
      • 2 yrs ago
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      nolesrule The other nice thing with the SIMPLE is that there isn't a problem if you add an employee, you just add them and match 3%, no big deal.  If you have a 2:1 401(k) match going on, you're in for a world of hurt when you hire a receptionist.

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      • nolesrule
      • YNAB4 Evangelist
      • nolesrule
      • 2 yrs ago
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      Alex_H Nah. Just go with Fidelity then, which I would recommend over Vanguard anyway. You can add in an hours per calendar year and/or employment tenure requirement (up to one year) as eligibility requirements. That gives plenty of lead time to change plans if one gets to that point. And once you hire an employee, there are going to be a ton more changes involved in the business that are avoided when you are self-employed and have no employees.

      The Fidelity retirement specialist I talked to on the phone walked me through the entire application. It took 10 minutes.

      Besides, in a one participant 401k plan, you do not have to specify the match or profit sharing contribution in writing... it just has to be equal for the owner and spouse.

      As for your psychobabble regarding 0 to > $12,500, I don't think that's actually relevant. You can save something either way, and both ways are easy. You are the one making it out to be difficult and apparently you've never actually done it. If you are running a business that is successful enough to be able to consider making retirement contribution and you don't have an IRS lien from spending what you should have paid in taxes, you've already got the mental capacity to handle the set-up and ongoing processes.

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