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SEP-IRA vs. 401(k): Planning for Business Owners

SEP-IRA vs. 401(k): Planning for Business Owners

April 24, 2024

IRA and 401(k) planning for business owners are critical parts of running a small business. Subtle differences between various plans can affect how you pursue your goals.

Two common investment vehicles for retirement are SEP-IRAs and 401(k) plans. Discover the differences between them and how to decide what’s best for your business.

Understanding Individual 401(k) Plans

401(k) plans are essentially savings accounts employers set up for workers; employees contribute part of their pre-tax paychecks into 401(k)s, and some employers match those contributions. Funds are then invested in financial vehicles like stocks, bonds, and mutual funds to grow over time.

Funds in 401(k)s are tax-deferred, which means contributions are tax-free, but withdrawals during retirement are taxable. Keep in mind that both the employee and the employer have annual contribution limits.

401(k) planning for business owners should align with IRS regulations. Self-employed business owners define age and service requirements for their employees’ plans. They can make plan enrollment immediate or set future dates or minimum hour requirements for acceptance in the plan.

Exploring SEP-IRAs

With Simplified Employee Pension Plans (SEP), only employers can contribute (individual employees cannot), and contributions are tax-deductible. In 2024, employers can contribute up to 25% of the employee’s salary or $69,000—whichever is lower.

Self-employed and small business owners are eligible for SEP-IRAs, as are their employees. SEP-IRAs are attractive to small business owners because they don’t require the complex administration, testing, and reporting requirements that 401(k)s do.

Individuals can choose their investment vehicles with SEP-IRAs, while with a 401(k), the plan provider can limit investment options.

SEP-IRA and 401(k) Planning for Business Owners: What Small and Self-Employed Businesses Need to Consider

Choosing between plans requires a bit of consideration. With SEP-IRA and 401(k) planning for business owners, some of these considerations include:

Employer and Employee Contributions

Employers can contribute to both funds, however, employees cannot contribute to SEP-IRAs.

Setup and Management

Many employers prefer the setup and management of SEP-IRAs because it is simplified compared to the processes for 401(k)s.

Loan Provisions

401(k) plan members can receive loans against their account balances, while SEP-IRA members must refrain from taking out these loans.

Long-Term Objectives and Sustained Growth

Small business owners and self-employed individuals might prefer SEP-IRAs for more simple, directed growth, while businesses expecting to expand and increase revenue may prefer 401(k) plans.

Tax Implications and Benefits

In both SEP-IRAs and 401(k)s, employers can make tax-deductible contributions to limit taxable income. Employees with SEP-IRA plans are not allowed to make contributions.

Both plans have similarities regarding investment growth, taxable post-retirement withdrawals, and required minimum distributions (RMDs). Withdrawals before age 59½ may incur penalties of 10% of the balance in both plans. RMDs are mandatory after individuals reach age 72, or 73 if they turned 72 after December 31, 2022.

Implementation and Administration

A SEP-IRA limits paperwork and has fewer administrative tasks as well as fewer compliance requirements.

401(k) planning for business owners requires more resources, documentation, and time to set up. Regular administration also takes more effort, as employers are required to have nondiscrimination testing, regular reports to government agencies, and more employee communications.

Case Studies

To demonstrate the effectiveness of a SEP-IRA, consider the following hypothetical: Susan is a self-employed programmer who’s owned her own business for 10 years and pulls in $80,000 in net earnings annually. She’s regularly contributed to her traditional IRA but has been looking for an alternative to save more. On the advice of a financial planner, she opens a SEP-IRA. 

Susan can now contribute up to 25% of her net earnings to her SEP-IRA, up to a maximum of $69,000 in 2024. So given her current income, she can contribute up to $20,000 to her retirement account and then deduct this amount from her taxable income. She monitors her contributions in future years, contributing more or less as the situation dictates. 

Certain case studies further reveal the capabilities of SEP-IRAs. Investor’s Business Daily outlined a scenario in which a small business owner could net over $1.08 million in retirement savings through a SEP-IRA—after taxes are withheld. 

SEP-IRA and 401(k) Planning for Business Owners: Decide Which Is Best for You

Do you need help determining the best fit for your unique circumstances? At Paragon Wealth Management in Doylestown, PA, we assist small business owners who want to maximize retirement savings and pursue long-term objectives. To schedule a meeting, reach out to us via our contact page, call (215) 348-3176, or email charlie@paragon-wealth.com.

Mark your calendars: We’re hosting an upcoming special event!

Success on Tap: Business Owners Social 

May 8, 2024

4:30 p.m. - 7:00 p.m.

PJ Whelihan’s 

4379 W Swamp Road

Doylestown, PA 18902

Special Guests: Ryan Perri (Inland Capital), Tony McMasters (Voya Financial), Brandon Luckett (CNL Strategic Capital), and Michael Brooks (Brooks Law). 

We hope to see you there!

About Charles

Charles McNamara, III (Charlie), is a Founding Partner, Financial Advisor, and President at Paragon Wealth Management, a financial services firm based in Doylestown, Pennsylvania, dedicated to professionally supporting, educating, and providing informed direction to each and every client. Charlie’s passion for working with clients one-on-one to find specialized solutions to pursue their financial goals drives the firm’s client-focused mission and continued success. He values the confidence clients have in him to always keep their best interests in mind.

A veteran of the financial services industry since 2000, Charlie brings an extraordinary level of knowledge and experience to the financial field. After obtaining a business finance degree from Delaware Valley University, he began his career as a financial advisor with Prudential Financial in 2001, and was promoted to management in only three years due to his hard work and dedication. With an entrepreneurial spirit and a passion for helping people solve problems, he launched his own practice in 2007.

When he’s not at work, Charlie spends time with his wife, Lisa (co-owner of local salon Moxie), daughter, Carissa, and their two dogs and cat. He enjoys weightlifting, running, golfing, fishing, and giving back to the community through his church, Our Lady of Mt. Carmel, and local organizations, such as the Travis Manion Foundation. To learn more about Charles, connect with him on LinkedIn.