A business owner may consider a Simplified Employee Pension IRA (SEP-IRA) for retirement planning purposes, but there are many advantages to placing funds in an individual 401(k) instead. In general, the individual 401(k) plan has more options and flexibility for a sole proprietor, especially one who might be catching up after years of reinvesting funds into a business instead of putting money away for retirement. Here is a summary of pros and cons you should consider before choosing either option:
- In an individual 401(k) plan, salary deferrals can be made on the first 100 percent of compensation up to $17,000 in 2012. An additional $5,500 can be deferred for those who have reached age 50 as a catch-up contribution. SEP-IRAs don’t have catch-up contributions. The salary deferrals can be pre-tax, or they can be treated as Roth contributions, or split.
- For all compensation levels under $200,000, a Section 401(k) plan will always permit higher contribution levels because of the salary deferral feature mentioned above. Otherwise, both plans permit deductible employer contributions up to 25 percent of pay, not to exceed $50,000 for any one person (or $55,500 with the catch-up contribution).
- An individual who is the trustee of his plan may invest plan monies in the broadest range of investments possible. The SEP-IRA investments are limited as permitted by the IRA custodian.
- Self-directed IRAs may permit the same investments as the self-trusteed 401(k) plan but come with expensive fees, like setup and transaction charges, which can easily exceed the administration costs of an individual 401(k) plan.
- Form 5500-EZ does not need to be filed by a one-participant 401(k) plan until the total asset value exceeds $250,000; SEP-IRAs do not need to file Form 5500
- The 401(k) plan allows participant loans up to $50,000. Any borrowing from a SEP-IRA is treated as a taxable distribution subject to potential excise tax for early distribution.
- Bankruptcy protection applies to both thanks to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCA); however, only qualified retirement plans under ERISA are shielded from other types of judgments, such as civil lawsuits.
Piercy Bowler Taylor & Kern has a Pension Plan Services practice to help entrepreneurs and business owners create and manage their tax-qualified retirement programs like the individual 401(k) plan. Contact us today at 702-384-1120 for more information.
Jay H. Beltz is PBTK’s Pension Plan Services Practice Leader. Jay is a pension consultant with more than 25 years designing, administering and consulting on tax-qualified retirement programs like defined benefit plans and Section 401(k) plans. He has been involved in establishing and terminating more than 5,000 plans and continues to advise all sizes of employers about the tax and savings benefit of such programs for their employee’s financial well-being.