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Individual 401k vs Sep for SE Person Earning $150K a Year

Saving for retirement is an important consideration for individuals, especially for those who are self-employed. There are several retirement plan options available, and two popular options for self-employed individuals we will discuss today are the Individual 401k and the SEP IRA.

While both plans have unique advantages, the Individual 401k may be the better option for someone earning $150,000 a year for the following reasons:

Here’s how to do it:

  1. Higher Contribution Limits: One significant advantage of an Individual 401k over a SEP IRA is the higher contribution limit. For the 2022 tax year, the maximum contribution limit for an Individual 401k is $61,000, which is significantly higher than the maximum contribution for a SEP IRA, which is 25% of compensation, up to a maximum of $61,000. For someone earning $150,000 a year, the maximum contribution to a SEP IRA would be $37,500. However, with an Individual 401k, that same person can contribute up to $61,000, allowing them to save more for retirement and potentially reduce their taxable income.

  2. Ability to Make Roth Contributions: Another advantage of an Individual 401k is the ability to make Roth contributions. With a Roth contribution, the money you contribute is after-tax, which means you won't get a tax deduction for the contribution. Still, you won't have to pay taxes on the money when you withdraw it in retirement, providing a huge advantage, especially for those who expect to be in a higher tax bracket in retirement. Both the contribution and the earnings grow tax free in a Roth 401K. With a SEP IRA, you can't make Roth type contributions, meaning that all contributions to the plan are pre-tax, and you'll have to pay taxes on the money when you withdraw it in retirement on both your original contribution, and the growth too.

  3. More Investment Options: Individual 401ks depending on the vendor you use to set up the account generally offer a wider range of investment options compared to SEP IRAs. With an Individual 401k, you can typically invest in a wide range of stocks, bonds, mutual funds, and other investment options. With a SEP IRA, you are typically limited to a smaller selection of investment options. While this may not be a significant issue for some investors, those who want more control over their investments may prefer an Individual 401k.

  4. Ability to Borrow from the Plan: Individual 401ks may allow you to borrow money from the plan, which can be a significant advantage for those who need access to cash but don't want to pay taxes or penalties for withdrawing money from the plan early. You still need to pay it back to avoid being taxed on the withdrawal within plan guidelines, With a SEP IRA, you can't borrow money from the plan. If you need cash, you'll have to withdraw money from the plan and pay taxes at any age. Be warned, there are extra tax penalties if you're under age 59 ½ and take money out of deferred tax retirement accounts.

  5. Easier to Administer: An Individual 401k may be easier to administer than a SEP IRA. With a SEP IRA, you'll typically need to establish a separate account for each employee, which can be time-consuming and expensive. With an Individual 401k, you can typically establish a single plan for yourself, even if you have employees, making it much easier to manage the plan and ensure that everyone is getting the maximum benefit, especially the owner. Sole proprietors take note, this could be a very flexible option for you to use. If you have only contractors, this is an easy win for the owner who only needs to consider their needs and no one else’s.

In conclusion, while both the Individual 401k and SEP IRA are excellent retirement plan options for self-employed individuals, the Individual 401k may be the better option for someone earning $150,000 a year.

With higher contribution limits, the ability to make Roth contributions, more investment options, the ability to borrow from the plan, and easier administration, the Individual 401k may provide more benefits and flexibility for those who want to save more for retirement.

It's essential to consult with a financial advisor to determine the best retirement plan for your specific circumstances and goals.

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