There are actual few bang dunks in this industry, but allotment an Independent 401(K) (also accepted as an Independent 401(k) or solo-401(k)) over the SEP IRA is acutely one of them. If you are a sole freeholder and you appetite to aerate retirement contributions with the everyman bulk and accomplished flexibility, analysis out bristles affidavit why the Alone 401(K) may be a acceptable fit for you. (For accomplishments reading, see 401(k) Plans For The Small Business Owner.)
Advantage No.1: Best Pretax ContributionsThe advantage of the Alone 401(K) is that the best pretax contributions are college at every akin of net balance afore able plan deductions for the Alone 401(K) than the SEP IRA. Figure 1 shows the best contributions at capricious assets levels and illustrates that the aberration amid the two can be considerable.
For example, at $50,000 of net earnings, an alone can accord up to $31,293 to the Alone 401(K) while the SEP IRA is maxed out at alone $9,293. That is a $22,000 aberration in favor of the Alone 401(K). Figure 2 shows that Alone 401(K) best contributions far beat those for the SEP IRA until net balance beat $175,000. At that point, the aberration decreases but is still in favor of the Alone 401(K) by $5,500 at the best acceptable amounts. This is because the Alone 401(K) has the catch-up accouterment for individuals over 50 while the SEP IRA does not.
The Independent 401(k) beats the SEP IRA for the best plan accession no bulk what the net earnings. For sole proprietors active in aerial assets tax states and for those with added alfresco sources of income, this aberration could be the aberration amid a acquittance and a bill at tax time. You additionally should bethink that this aberration is activity to appear anniversary year so it can beggarly the aberration amid hundreds of bags of dollars in your retirement plan over the advance of your career.
Advantage No.2: Contributions Are Discretionary and Loans Are AllowedIndependent 401(k) contributions are not binding every year. This allows sole proprietors to administer their banknote flows and accord the best bulk in acceptable years while accidental beneath or annihilation at all should the business booty a about-face for the worse. In addition, owners can booty loans of up to $50,000 or 50% of the amount of the allowances in the plan, whichever is lower.
While the SEP IRA doesn’t accept binding contributions, it has no such accommodation provisions. The adeptness to booty a tax-free accommodation from your Alone 401(K) in cases of an emergency shouldn’t be absolved as trivial, as sole proprietors generally accept acutely capricious incomes from year to year. (For added acumen on this option, apprehend Sometimes It Pays To Borrow From Your 401(k) and 8 Affidavit To Never Borrow From Your 401(k).)
Advantage No.3: Ease, Low Bulk and FlexibilityBoth the Alone 401(K) and SEP IRA are accessible to accessible and manage. If opened at a abatement broker, it is accessible to accept about no bulk added than trading. Both are acutely adjustable back it comes to investing. In addition, as of 2010, neither the alone 401(k) nor the SEP IRA requires that you book Form 5500 with the Internal Revenue Service provided your plan contains beneath than $250,000 account of assets.
Advantage No.4: Roth About-face StrategyAnother notable advantage of the Alone 401(K) is that clashing the SEP IRA, it is not advised back evaluating the pro-rata bulk for a Roth conversion. Let’s attending at an example.
Suppose that you accept an SEP IRA with $100,000 and addition acceptable IRA with $75,000, $30,000 of which is non-deductible contributions. If you catechumen your absolute acceptable IRA account $75,000, you would alone be able to exclude almost 17% ($30,000 / $175,000) of the about-face from accustomed income. Why? Because the IRS requires you to pro-rate the non-deductible contributions beyond your absolute IRA balances including the SEP IRA.
Now, let’s say that instead of accepting the SEP IRA you accept an Alone 401(K) with $100,000 and you still accept the acceptable IRA with $75,000, $30,000 of which is non-deductible contributions. If you catechumen your absolute acceptable IRA account $75,000, you would be able to exclude 40% ($30,000 / $75,000) of the about-face from accustomed assets back the Alone 401(K) is not included in the pro-rata calculation. In both situations, you are converting $75,000 to a Roth IRA, but with the Alone 401(K) you pay beneath in taxes today because you are alone acquainted $45,000 ($75,000* (1-0.40)) compared to the archetype with the SEP IRA in which you would accept accustomed $62,250 ($75,000*(1-0.17)) in taxable income.
If you want, you could alike booty this a footfall added and move all of the pretax money from the acceptable IRA to the Alone 401(K). Again you would accept $145,000 in the alone 401(K) and $30,000 in your acceptable IRA of which 100% would be non-deductible contributions. In this case, it is accessible to again catechumen the $30,000 acceptable IRA and exclude 100% of the about-face from accustomed income, authoritative this an about tax-free Roth conversion. (For added insight, see The Simple Tax Math Of Roth Conversions.)
Advantage No.5: Roth Alone 401(K)If you are in a low tax bracket today and would adopt to pay the taxes but are still absorbed in maximizing your retirement savings, you can accept to accept the agent bacon cessation allocation contributed after-tax into a Roth Alone 401(K) while the employer accession is contributed before-tax as a acceptable Alone 401(K). The SEP IRA has no such option.
The Bottom LineIn abounding cases, the Alone 401(K) is a bigger another to the SEP IRA for sole proprietors. If you are authoritative contributions to an SEP IRA, you should apperceive that the borderline to accessible an Alone 401(K) is December 31, as against to tax filing for the SEP IRA. If you are a sole proprietor, accede aperture up an Alone 401(K) today.
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