Solo 401(k)s vs SEP IRAs vs SIMPLE IRAs: Retirement Plans for Small Business Owners

Solo 401(k)s, SEP and SIMPLE IRAs were created for small business owners and self-employed individuals who want to capture tax-advantaged retirement savings for themselves and their employees. These plans can be self-directed, allowing account owners to make their own investment choices and use alternative assets to grow retirement wealth. This article compares solo 401(k)s vs SEP IRAs vs SIMPLE IRAs to help you choose which plan is best for you and your business.

Solo 401(k)

The solo 401(k) is a retirement plan for small business owners who want the same advantages that typical 401(k)s offer larger corporations. As the business owner, you can make contributions as both an employer and as employee to maximize your investing power and retirement income.

This plan is the most beneficial for:

• • People who own a business with no employees besides themselves, spouses, and/or business partners.
  • Those who own a side business apart from their full-time job.

Plan features:

• • Allows pre-tax employer and employee contributions.
  • Potential for Roth and mega Roth employee contributions. Discuss these options with your plan administrator as these features impact whether contributions are made with pre-tax or post-tax dollars.
  • The employer contribution is a tax deduction for the business.
  • 2022 combined total employer/employee contribution for ages under 50 is $61,000 (salary deferral + profit-share match). For those 50 and over the total combined limit, including a catch-up contribution, is $67,500.
  • 2023 total contributions for those under 50 is $66,000 and the combined total plus catch-up limit if 50 and over is $73,500.
  • Distributions of pre-tax contributions are taxable in retirement.
  • Distributions of post-tax (Roth) contributions are not taxed.
  • You can personally borrow up to 50 percent (or up to $50,000) of your solo 401(k).

Deadline to open and contribute to a solo 401(k):

For established plans, the deadline to make contributions differs for employer and employee contributions. Employee contributions must be made by December 31^st since their W-2s are due by January 31^st. But employers have until their income tax filing date, including extensions, to open a plan and make employer contributions to a solo 401(k).

Section 317 of the SECURE Act 2.0 (passed in late 2022) added a special provision for sole proprietors and single-member LLCs when they first open a solo 401(k):

Beginning in 2023, if these employers establish new solo 401(k) plans after the end of the taxable year and before the employer’s tax-filing date, employee contributions can be made up to the date the employee files their taxes. Keep in mind this provision is only allowed in the first year the new solo 401(k) is established. After that first year, employee contributions must be made by December 31^st of the tax-reporting year to count for that year. Employers still have until their tax-filing date to make contributions count for that tax-reporting year.

SEP IRA: Simplified Employee Pension Plan

This SEP IRA is easy to manage and affordable for employers to make contributions to employees’ IRAs held at institutions of their choice. These plans have high contribution limits based on employee compensation, which gives account owners ample capital to invest.

This plan is most beneficial for:

• • Self-employed individuals and sole proprietors.

Plan features:

• • SEP IRAs have lower start-up fees and operating costs than 401(k)s and other profit-sharing savings plans.
  • All employees must receive the same benefits, but employers are not locked into making contributions every year.
  • Employers can contribute up to 25 percent of each employee’s compensation.
  • Employer contributions are tax deductible for their business.
  • The annual 2023 contribution limit is the lesser of $66,000 or 25 percent of an employee’s compensation.
  • The SECURE Act 2.0 allows Roth options for both employer and employee contributions beginning with the 2023 tax year and beyond.
  • Pre-tax distributions are taxed upon withdrawals which can be taken after the participant reaches the age of 59 ½.
  • Roth contribution portions are made with post-tax dollars and distributions in retirement are not taxable.

NOTE: There are special rules regarding contributions for self-employed individuals who are also considered employees relevant to SEP IRAs. Contact a financial professional for more information on complying with IRA regulations regarding contributions and other details.

Deadline to open a SEP IRA:

You have until April 15 (plus extensions) to establish a SEP IRA for the current tax-reporting year. For example, you have until April 15, 2024, to establish a plan for the 2023 tax year.

Deadline to make contributions:

You can make contributions up until April 15, 2024 (plus extensions) to count for the 2023 tax-reporting year.

SIMPLE IRA: Savings Incentive Match Plan for Employees

SIMPLE IRAs have minimal start-up and administrative costs compared to some other plans. Employers who offer SIMPLE IRAs enjoy the benefits of reducing business taxes and the flexibility of deciding how much they contribute to their employees’ plans.

This plan is most beneficial for:

• • Small businesses with fewer than 100 employees.

Plan features:

• • Contributions include both employee salary reduction contributions, as well as either employer matching contributions or non-elective contributions.
  • Employees can contribute up to $14,000 (plus a $3,000 catch-up contribution if 50 and older) in 2022 and $15,500 in 2023 with an additional catch-up contribution of $3,500 for those aged 50 and older.
  • Employers can match employees’ contributions dollar-for-dollar of up to 3 percent of the employees’ deferral contributions or they can make non-elective contributions of up to 2 percent of an employee’s compensation.
  • Potential to reduce business income tax liability.
  • Contributions grow tax-free, and taxes are paid on distribution at retirement based on the applicable tax rate at that time.
  • SIMPLE IRAs now have Roth contribution options beginning with the 2023 tax year and beyond thanks to the passage of the SECURE Act 2.0.
  • Distributions in retirement for pre-tax contributions are taxable; distributions of Roth contributions are not taxed.

Deadline for opening a SIMPLE IRA:

This plan must be established between January 1 and October 1 in the year you want contributions to count on your tax return. So, you have until October 1, 2023, to establish an account for the 2023 tax-reporting year or until October 1, 2024, for the 2024 tax-reporting year.

Deadline for making contributions:

You have until October 1^st of the tax reporting year to make all contributions to a SIMPLE IRA. This plan doesn’t offer an extended period to make contributions made in the current year count towards the previous tax-reporting year.

Self-Direct Your Retirement Plan to Gain Access to Alternative Investments

Self-directed retirement plans are perfect for individuals who want control of their investing funds and decisions, offering a hands-on approach to building wealth. Many small business owners and self-employed individuals look beyond traditional stocks, bonds, and mutual funds for investment opportunities.

A self-directed SEP or SIMPLE IRA or a solo 401(k) opens the door to diverse, alternative investments while providing higher contribution limits, as well. Investing in assets you know and understand can provide a level of comfort and possibly increase your chances for building wealth at a faster rate than traditional options allow. Plus, alternative assets give you the chance to step off Wall Street and counter the stock market’s volatility.

Popular examples of alternative assets:

• • Real estate
  • Private lending
  • Cryptocurrency
  • Tax liens and certificates
  • Precious metals
  • And more…

These are only a few of the almost unlimited alternative assets available for self-directing. This offers you the flexibility to choose what’s right for you while maintaining control of your savings plan.

Want to Offer a Self-Directed IRA for Your Small Business?

Solo 401(k)s, SEP and SIMPLE IRAs for small business owners are worth consideration. But they aren’t the only savings plans available to you. You can also self-direct a health savings account (HSA) to build tax-advantaged savings to pay for qualified medical costs.

And, if you decide to offer a self-directed savings plan for your business, Advanta IRA makes it easy. We ensure the administrative details of our clients’ plans comply with IRS regulations. We do not sell investments or give investment advice, so our clients have the complete control to choose their own assets for their plans.

To learn more about self-directed solo 401(k)s, SEP and SIMPLE IRAs and take advantage of the savings for yourself and qualified employees, contact Advanta IRA today.

Additional reading about retirement plans for small business owners:

SECURE Act 2.0 Provisions for Roth SEP IRAs and SIMPLE IRAs

FAQs about How a Checkbook Control IRA Works

10 FAQs about a Self-Directed IRA (SDIRA) + Alternative Investments

 

This article was originally published on August 27, 2022, but has been updated with current information.