6 minute readFor more information, see our Retirement Plan Comparison Chart!
For your self-employed clients, the common question is, which retirement plan is right for me? Is it a Simplified Employee Pension (SEP IRA), Savings Incentive Match Plan for Employees (SIMPLE IRA, or a Solo 401(K) plan?
It might be helpful to begin with basic definitions of the three plans. (1) (2) (3) (4)
Solo 401(K)
Despite "Solo" in the plan's name, it has nothing to do with Star Wars.
A Solo 401(K) is designed for self-employed entrepreneur clients. Think of this, with a few differences, as a regular 401(K) account, except your client is the only employee in the business and, typically, the only plan participant other than their spouse.
The drawback is that if your client wants to have employees in the future, this is not the right plan. With a Solo IRA, you cannot have non-spousal employees, so you must be sure that your client's plans do not include expanding and hiring.
SEP IRA
A SEP IRA operates as a traditional IRA with two major differences; the amount your client can place in a SEP IRA, and it can only accept employer contributions. A SEP-IRA is a retirement plan that can be set up with little administration and no tax filing. It is a flexible plan that allows your client to change contributions from year to year or even skip a year. Contributions vest immediately.
SIMPLE IRA
Same as a traditional IRA except for the contribution amounts and that both the employer and the employee can contribute to these plans. A SIMPLE IRA is built for employers with 100 or fewer employees and reduces the typical tax and regulatory complexities that generally come with qualified plans. Contributions vest immediately.
Let us unpack these for you, and click here to receive a one-page chart comparing these three plan plans. (1) (2) (3) (4)
Which plan allows me to contribute the most into my retirement plan?
Winner:
Solo 401(k)
A Solo 401(K) plan allows your client in 2023, as an employee of their business, a deferral limit of $22,500 plus a catch contribution if they are 50 or older of $7,500. Then, your client, as the employer, can add an additional $43,000 to the Solo 401(K), bringing the total to $73,500 for those over age 50.
Runner-up
SEP IRA
In 2023, your client can add up to $66,000 to their SEP IRA or 25% of the employee's income. No catch-up provisions are allowed for employees 50 years or older in a SEP IRA.
Bringing up the rear
SIMPLE IRA
The maximum for a SIMPLE IRA is $15,500 for 2023, plus a $3,500 catch-up provision for those 50 or older.
Which plan can be established with less complexity?
Winners
SEP IRA and SIMPLE IRA
Both the SEP-IRA and the Simple IRA are easy to establish
Bring up the rear
Solo 401(K)
Solo 401(K) require set-up and fees.
Which plan is best for self-employed clients with no full-time employees other than a partner or spouse?
Winner:
Solo 401(k)
Essentially, Solo 401(K) will cover your client only, perhaps their spouse, while providing a maximum contribution among the three plans and is flexible.
Runner-up
SEP IRA
A SEP IRA works well if the client is the only employee but keep in mind they must include employees if they have: attained age 21, worked for your client's business in at least three of the last five years, received at least $750 in 2022; $650 in 2021 and 2022; $600 in compensation (in 2016 - 2020) from your client's business.
Bringing up the rear
SIMPLE IRA
The least generous plan in terms of contributions. A SIMPLE IRA can be established for 1 to 100 employees.
Best if business income is inconsistent.
Winners
SEP IRA and Solo 401(K)
Both The SEP-IRA and the Solo 401(K) work well if business income is low or inconsistent.
Bring up the rear
SIMPLE IRA
A SIMPLE IRA requires Contributions every year either as:
- Dollar-for-dollar match of employee contribution up to 3% of each employee's contribution.
- A contribution of 2% of each employee's compensation. Solo 401(K).
Vesting
Winner
Solo 401(K) and client-only SEP IRA and SIMPLE IRAs
Bring up the rear
SIMPLE IRA and SEP IRAs with employees
Keep in mind that contributions vest immediately.
IRS Reporting
Winner
SIMPLE and SEP IRAs
No annual IRS reporting.
Bring up the rear
Solo 401(K)
If the plan has $250,000 or more by the end of the year, it is generally required to file its annual report on Form 5500-EZ. If the Solo plan has less than $250,000, it may be exempt from the annual filing requirement.
Availability of a Roth Option.
Winner
Solo 401(K)
A Roth Solo 401(k) is available and can allow your client to make after-tax contributions, have assets grow tax-free, and withdraw them tax-free at retirement provided they reached age 59 ½ and the account was open for at least five years.
Bring up the rear
SIMPLE IRA and SEP IRAs
SIMPLE IRAs and SEP IRAs do not have Roth IRAs available to them. Only Traditional versions of an IRA are available to these plans.
Availability of participant loans.
Winner
Solo 401(K)
A Solo 401(k) offers optional participant loans and hardship withdrawals, adding flexibility to the plan.
Bring up the rear
SIMPLE IRA and SEP IRAs
IRA-based plans like SIMPLE and SEP IRA cannot offer participant loans. However, they can take a distribution at any time, which will be includible in your client's taxable income and may be subject to a 10% penalty if they are under age 59 ½.
Call Dunham at (858) 964 – 0500 to discuss a vendor we work with who can set up a Solo 401(K) for as little as $250 and charge as little as a $300 annual TPA fee.
Sources:
(1) https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps
(2) https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-simple-ira-plans
(3) https://www.irs.gov/retirement-plans/one-participant-401k-plans
(4) https://www.irs.gov/retirement-plans/retirement-plans-for-self-employed-people
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