Retirement Plan Options For The Self-Employed: Solo 401(k)s vs. SEPs
(Part three of a series on retirement planning. In previous installments of this series we examined defined benefit plans and matching and Safe Harbor 401(k)s. This month we take a look at Solo 401(k)s and SEPs.)
Experts estimate that Americans will need 60 to 80 percent of their pre-retirement income to maintain their current standard of living when they stop working. If you are the sole owner of a small business, pension plans are a great way to build wealth to ensure that you can retire comfortably. They are also great tax-saving tools that can benefit your business today.
The two most common retirement plans available to the sole owner are the more traditional SEP (Simplified Employee Pension plan) and the Solo (Self-Employed) 401(k) that was introduced in 2001 under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).
Deciding which retirement plan is right for you can be confusing. Which would be better for you: a SEP or a Solo 401(k)?
The Solo 401(k)
The Solo 401(k) is a plan designed to accept employee salary deferral contributions plus a profit sharing portion. (See part two of this series.)
This means for 2007, the Solo 401(k) allows a self-employed person to make a contribution of 25 percent of earned income (net profit from your Schedule C minus one-half of self-employment tax minus the contribution), plus salary deferrals of $15,500 with a maximum contribution not to exceed $45,000. Individuals 50 and older can make an additional $5,000 catch-up contribution and invest a maximum $50,000.
The SEP
The SEP, on the other hand, only allows you to contribute the profit sharing portion. The Internal Revenue Code for 2007 allows the same maximum contribution of $45,000 or $50,000 for those 50 and older. Let’s look at some examples to clarify the differences between these plans.
