Financial planning, especially retirement plans, can be a tricky business with their countless fine prints and obscure terms. However, a good retirement plan is also an unavoidable necessity. This is especially true for self-employed professionals who do not have the luxury of a company provided retirement plan or a pension scheme. You are left entirely on your own to choose a plan that is adequate for a comfortable retirement.
The Self Employed Pension IRA (SEP-IRA) and individual 401k have traditionally been the two most favored retirement schemes on account of their contribution limits and annual contributions that are both high and flexible. However, there are subtle yet important differences between these two retirement plans that any self-employed person shopping for retirement plans should be aware of.
For example, solo 401k retirement plans entail greater administrative role in contrast to SEP. However, 401k plans also permit individuals to make a high annual contribution at similar income levels as a consequence of their specific calculation methodology. Similarly, you should consider whether you would like facilities such as drawing a loan against your retirement plan. While 401k allows individuals to borrow with their retirement plan balance serving as collateral, IRS rules forbid grant of loans in an SEP IRA retirement plan.
Self Employed Pension IRA
SEP IRA is an excellent choice for self-employed individuals who would like to contribute up to 25 percent of their net self-employment income, subject to a maximum of $53,000. The retirement plan itself is easy to procure and entails minimal administrative responsibilities.
One of the chief benefits of SEP IRA is that it allows contributors to switch to individual 401k plans at a later date. For example, a contributor may want to avail loans against his contribution to the retirement fund, or he may want to contribute more than SEP IRA calculations permit. In such cases, the individual can have his SEP IRA retirement plan converted to 401k, with the concurrent transfer of retirement assets, after completion of certain mandatory administrative procedures.
401k retirement plan
While both SEP IRA and 401k retirement plans have similar maximum annual contribution limit, the latter’s different calculation methodology permits individuals at similar income levels to contribute more in his 401k retirement plan. Thus, it provides you the double benefit of maximizing your retirement returns as well as helping you avail attractive tax deductions.
Similarly, easy access to credit is always important to self-employed individuals who may need it to expand their business. The option to avail loan against one’s retirement fund balance is a supremely attractive feature making 401k doubly attractive compared to SEP IRA. To conclude, for a self-employed 401k vs. a SEP can be determined by his specific retirement goals and credit requirements.