By The AllGen Team
Self-employed individuals face unique financial planning challenges when it comes to retirement savings. The individual 401(k) and the SEP IRA are two popular options. While each option has different features and qualifying restrictions, they both offer tax incentives and have the potential for saving a significant amount of money for retirement.
In this article, we explain the key differences between these two plans so you can decide which one aligns the closest to your individual financial goals.
Understanding the Individual 401(k)
An individual 401(k), sometimes referred to as a solo 401(k), is a retirement savings plan created especially for independent contractors and companies without workers. It functions similarly to a conventional 401(k) provided by corporations, but with more flexible contribution caps.
Individual 401(k)s can be funded by the company as well as the employee. When compared to other retirement plans, this dual contribution capability offers potentially large savings. You can also choose from a variety of investment options, giving you complete control over your retirement account.
The ability to borrow money from your account under specific circumstances is a major perk that can come in handy for emergencies. However, it’s crucial to remember that because there could be tax repercussions and a chance of depleting retirement savings, borrowing money from a retirement account should typically only be done as a last resort.
All things considered, an individual 401(k) provides self-employed people with a powerful tool for creating significant retirement savings.
Understanding the SEP IRA
A Simplified Employee Pension (SEP) IRA is a retirement savings plan intended for independent contractors and small companies with employees. When compared to other retirement plans, this one is relatively straightforward.
A SEP IRA allows the employer—or you if you work for yourself—to contribute to the individual retirement accounts (IRAs) that you and any other qualified employee have opened. The employer is able to deduct these donations from taxes. Typically, the contribution is expressed as a percentage of the worker’s salary.
SEP IRAs allow for flexibility because annual contributions are not required. If you decide to make contributions in a particular year, though, you have to contribute to every eligible employee. In addition, there are annual caps on contributions.
SEP IRAs make retirement savings easier, but they might not have the same flexibility or contribution caps as an individual 401(k).
How to Decide Which Retirement Plan Is Right for You
The decision between an individual 401(k) and a SEP IRA is primarily based on your unique situation. Below is a summary of factors to think about:
- Complexity: Generally speaking, 401(k)s are more complex than SEP IRAs. This is because 401(k)s offer loan provisions, employer-matching contributions, and require annual reporting to the IRS.
- Tax ramifications: Contributions to individual 401(k)s and SEP IRAs are both tax-deductible and grow tax-deferred. SEP IRAs have more restricted contribution and investment possibilities, whereas individual 401(k)s offer more freedom with alternatives, including Roth contributions and possible tax-free withdrawals in retirement.
- Number of employees: SEP IRAs are best suited for small businesses with a limited number of employees beyond the owner and the spouse. On the other hand, individual 401(k)s are limited to companies with no employees other than the owner and the spouse.
- Needs for borrowing: Personal 401(k)s provide loans against the value of your account, giving you possible access to money in an emergency. This loan provision is not available in SEP IRAs, which restricts your possibilities for accessing money prior to retirement.
- Investment possibilities: Both individual 401(k)s and SEP IRAs allow investments in mutual funds, ETFs, and individual stocks.
- Contribution caps: Because individual 401(k)s allow contributions from both employers and employees, they often have larger contribution caps. While SEP IRAs allow you to contribute a percentage of your W-2 wages or earnings (if sole proprietor), an Individual 401K allows for an additional $23,000 ($30,000 if over 50 years old) as of 2024 above the same percentage match allowed by the SEP IRA.
In the end, making the right decision between an individual 401(k) and SEP IRA is entirely contingent on your unique financial circumstances and objectives.
Partner With a Professional
Don’t wait to start saving for retirement! Our team at AllGen Financial Advisors, Inc. can help you decide whether an individual 401(k) or a SEP IRA is right for you.
We’re in this business because we’re passionate about using money as a tool to support freedom and impact. Anyone who has ever walked in our door (regardless of their generation) knows they can rely on us for insight.
To schedule a complimentary meeting, call (407) 210-3888 or email roldan@allgenfinancial.com.
About AllGen
Based in Orlando, Florida, AllGen Financial Advisors, Inc. is an independent, fee-based Registered Investment Advisor (RIA) firm dedicated to helping individuals and businesses maximize their financial resources. The AllGen team comprises trusted advisors, each with specialized skills, providing comprehensive guidance and tools to clients at any stage of life or socio-economic position to experience and maintain financial freedom. AllGen offers highly tailored financial planning and investment management, helping clients understand their current financial situation and define their future goals. The team develops and executes customized plans to pursue these goals, managing and tracking investments and financial progress along the way. Known for being relatable and approachable, AllGen’s advisors leverage their vast experiences, education, and interests to make complex financial concepts understandable and personal. At AllGen, clients are treated as individuals, not just numbers.
