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Solo 401k vs SEP IRA (SELF-EMPLOYED: WATCH NOW!) - YouTube
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- Are you self-employed and you
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finally want to invest your savings
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while lowering your taxes?
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Maybe you've had a
successful year as a realtor
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or interior designer
or a TikTok influencer?
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In this video, we'll do
a side-by-side comparison
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of the two most popular
ways you can create
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your own retirement
plan as a self-employed
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or small business owner,
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solo 401k versus SEP IRA,
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and we'll do five rounds.
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(ambient music)
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Round number one on solo
401k versus SEP IRA:
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Who can participate?
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So let's say you're a TikTok influencer,
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you just hit 1 million subscribers,
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and you're now raking in the money
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with ads and sponsorships
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and you want to invest
that money wisely, right?
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So good news:
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You can contribute as
a self-employed person,
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either through a solo 401k
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or a SEP IRA,
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you can do both, but there
is one important difference.
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If you create a solo 401k,
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you can contribute both as
the employer and employee.
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With a SEP IRA, you can
only contribute as employer.
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Now, you're probably
like, "Why do I care?"
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Well, you probably won't care if
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you are both employee and the employer,
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you're just a solo shop.
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But if you have a W2,
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let's say you've hired a virtual
assistant to help you out
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and you're paying him or her a W2 salary
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then you cannot contribute
through a solo 401k.
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That's why they call it solo 401k
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because you need to be flying solo.
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Now you can contribute as a SEP IRA
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if you have a W2 employee, but take note.
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If you, let's say, put in
10 percent of your income
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to your SEP IRA,
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you also need to be
contributing 10 percent
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of your W2 employee's income
to his or her SEP IRA.
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So given that there's both pros and cons
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for solo 401k and SEP IRA here.
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So we'll probably make it a tie
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for round number one.
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Bonus question for this round:
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If you're interior designer
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and you have an S-corp, S-corporation,
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can you set up a solo 401k?
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The answer is yes.
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If you're a sole proprietor,
or if you run an S-Corp
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or an LLC, you can contribute to solo 401k
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as long as you do not have a W2 employee.
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Round number two on solo
401k versus SEP IRA:
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What are the contribution limits?
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For both solo 401k and SEP IRA
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you can contribute up to 25 percent
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of your compensation up to a maximum
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of 57,000 for 2020
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and 58,000 for tax year 2021.
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This is specifically for
employer contributions.
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Now think about that for a second.
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Most of your friends or
neighbors are probably
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regular employees with access to a 401k.
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They can only contribute
at least for 2020, 19,500.
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You, as a self-employed
and a small business owner
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can put in as much as 57,000 for 2020.
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So this is really where
you can take advantage
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of being a self-employed person.
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Now, based on my
experience that 25 percent
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of compensation after a bunch
of deductions and adjustments
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that really comes down to just about
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over 18 percent of your compensation.
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So make sure you consult
your tax accountant
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about exactly how much you can contribute.
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Now, with a solo 401k in addition to
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that contribution that you can make
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as the employer, you can
also make another round
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of contributions as an employee.
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As an employee, you can contribute up to
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19,500 for 2020 and 2021.
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So let's say you are a realtor
in the Washington DC area
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and for 2020,
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you made $200,000 in income
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with the help of the
crazy real estate market
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that we're currently in.
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And so let's say you decide
to contribute 18 percent
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of your compensation as
employer towards your solo 401k.
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So that is 36,000, right?
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And you can do that
either through a solo 401k
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and SEP IRA, but through a solo 401k
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you can contribute an additional 19,500
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as the employee for a total of 55,500.
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So for round two, solo 401k
easily wins because of this.
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Now, if you're finding this video valuable
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please do click on the like button below.
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Round number three on
solo 401k versus SEP IRA:
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When is the contribution deadline?
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For tax year 2020 it is May 17, 2021.
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That's both for the solo
401k contribution deadline
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and the SEP IRA contribution deadline.
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Now, this is specifically
for employer contributions.
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If you're doing a solo 401k
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and you're just creating the plan now
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then you cannot contribute as an employee
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for 2020 unfortunately,
you can do that for 2021,
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but not for 2020.
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Now, regardless, the takeaway here is
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you still have time to do this
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until the tax deadline, so
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do your future self a favor
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and maybe you can pause uploading
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TikTok videos for a day or two
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and do this contribution for
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either solo 401k or SEP IRA.
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For this round I would say it's a tie
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between the solo 401k and the SEP IRA
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because they more or less have
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the same contribution deadline.
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If you do have questions at this point
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feel free to type them in
the comments section below.
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And now I have a quick question for you.
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Do you prefer to pay higher taxes
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or lower taxes?
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Round number four on
solo 401k versus SEP IRA:
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Which is better for your taxes?
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Now let's say you're an interior designer
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and you've had an excellent year.
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A lot of people are spending
on home improvement stuff
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and you decide to contribute to a SEP IRA.
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The advantage of that is
you get to deduct that
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from your tax tax return.
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So you pay lower taxes for this year
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but once you withdraw that
money from your SEP IRA
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when you're retired, then
you have to pay federal
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and maybe state income
taxes when you do so.
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Now with the solo 401k,
you have the option
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to contribute pre-tax,
meaning you get to deduct
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those contributions from
your tax return this year
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or you can contribute
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post-tax through the
solo Roth 401k option.
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If you do the latter,
then you pay taxes now
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but you let your
investments grow tax free.
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When you take it out during retirement
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you don't pay a single dime in taxes.
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Now for this round, I'd say
solo 401k wins pretty easily.
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Round number five, last round on
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solo 401k versus SEP IRA:
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How easy is it to set it up and maintain?
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Well, they're both easy to set up.
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With a solo 401k, when
you open one through
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a financial institution, a brokerage firm,
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they will provide for you, usually,
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the solo 401k plan document
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which you just review,
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click on a couple of options, sign.
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Pretty easy.
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Now there are several solo 401k vendors
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or solo 401k providers
that you can choose from.
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If you're a fan of Vanguard
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there is a Vanguard solo
401k. Fidelity, solo 401k.
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There's one, if you're a fan of E-Trade,
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there's an E-Trade solo 401k.
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Now, for those of you
who are Vanguard fans,
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one drawback here is
Vanguard currently does not
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allow you to move an existing IRA
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of yours into your solo 401k.
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So I've been actually calling Vanguard
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for the past two years
because we have a client
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that has a Vanguard solo 401k account
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and he wanted to move his IRA
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into his Vanguard solo
401k for various reasons.
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And they said, "We're considering it,
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it's going to come, it's going to come."
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but it never came for two years
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and we decided added to just create
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another solo 401k plan with E-trade.
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So just make a note of that.
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For Fidelity solo 401ks,
one major drawback
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for the Fidelity solo 401k is
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they do not have
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a solo Roth 401k option,
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which is pretty sad.
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If you're setting up a SEP IRA,
it's pretty straightforward.
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You can easily see the
SEP IRA option there
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under retirement.
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One thing that lot of people forget is
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in addition to creating
the actual SEP IRA account,
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you also need to fill up a form
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that's called form 5305-SEP.
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5305-SEP.
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You can Google that. Don't be intimidated.
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It's only half a page long
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and you don't need to
file it with the IRS.
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You just sign and date it to complete it
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and just file it away
in case you're audited.
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So how easy is it to maintain
a SEP IRA and a solo 401k?
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Well, they're both pretty
easy, but for a solo 401k
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once the plans assets reach 250,000
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then you are not required by law
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to file a form 5500 each year
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in order to comply with IRS rules.
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So for this round, I'm going to give it
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to SEP IRA because it
entails less paperwork.
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So who wins our solo 401k
versus SEP IRA match?
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Well, I'm counting two ties and solo 401k
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got two points, and one point for SEP IRA.
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Solo 401k wins!
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Now, which one is actually best for you,
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it really depends on your situation.
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You would want to consult
a financial planner.
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If you can contribute a lot of money
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most likely you can do solo 401k.
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If you prefer something that is easier to
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administer less paperwork
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you may want to consider a SEP IRA.
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Now that you have a retirement
plan for your small business
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don't forget that you can still contribute
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to either a traditional IRA or Roth IRA.
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in addition to the solo 401k or SEP IRA
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that you just set up.
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If you want to grow your money tax free
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but you can no longer contribute
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money into a Roth IRA, check out our video
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on how to do a backdoor Roth IRA.
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Three simple steps.
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