Bogleheads

[CaptSJD]

For a sole proprietor which retirement option would be the better choice and why?

[DSInvestor]

Hi Captain, I used to use SEP-IRA before Solo 401k was available. SEP-IRA is a good plan that's easy to use with high contribution limits of 49K. Your income has to be quite high to hit the 49K limit (approx 250K as sole proprietor).

I switched to Solo 401k a couple of years ago because it allows for higher contributions for lower incomes. Solo 401k has higher administrative burden. If plan assets exceed 250K, you'd need to file annual tax report Form 5500 with IRS.

I would recommend SEP-IRA over solo 401k if you're able save what you want to save using SEP-IRA. If you're able to max out a SEP-IRA, there's no reason to use solo 401k with it's extra admin requirements.

I look at solo 401k as SEP-IRA plus 16.5K. If you find that your income is such that you can contribute 10K with SEP-IRA, solo 401k would allow you to contribute 10K employer profit share + 16.5K salary deferral = 26.5K. This is quite a big difference in contribution on the same level of income.

Not all solo 401k plans are the same.

My Fidelity Self Employed 401k does not have ROTH option for the salary deferral but this plan accepts rollovers from many account types and I can invest in anything that I can buy in a Fidelity retirement brokerage account.

Vanguard's Individual 401k has a ROTH option so you can direct your 16.5K salary deferral contribution to ROTH and/or Trad in any proportion. The employer profit share contributions must go into the Traditional Solo 401k account. You can only invest in Vanguard mutual funds. No rollovers accepted unless they they are from another solo 401k.

[CaptSJD]

Thanks DSI for the explanation between the two. What I really meant was to know if the Roth 401K is better in the long run. My understanding is if I want to leave tax free money to my heirs, then anything in any type of Roth account would be the best choice. I hope I didn't confuse you.

[DSInvestor]

SEP-IRA should be compared to Solo 401k (which may or may not have ROTH option). SEP-IRA contributions are deductible to the business.

If you don't make any salary deferral contributions, solo 401k's employer profit share has the same tax attributes and treatment as SEP-IRA but with extra paperwork.

If have a solo 401k plan with a ROTH option, it applies only to the salary deferral contribution of 16.5K. As such, the decision for ROTH vs traditional for solo 401k is the same as for the big company 401k plans.

The finance buff as a page on the case against ROTH-401k.
http://thefinancebuff.com/2008....-401k.html

[CaptSJD]

Thanks again DSI. That is a great article!

Scott

[Jack]

If your income is below the Roth conversion limits, a SEP allows the choice of either tax deferred or tax free investing. You can convert a SEP to a Roth at any time.

[ObliviousInvestor]

Just ran across this thread. DSInvestor did a great job laying out the differences.

I just wanted to point out though that for sole proprietors (or LLCs taxed as sole proprietorships) SEP contributions are not deductible to the business. They're deducted on line 28 of Form 1040 rather than on Schedule C. (The significance here being that they don't save you any money on self-employment tax.)
_________________
Oblivious Investing: Building wealth by ignoring the noise.

[geekmedic]

I think I'm clear on this, but was curious if somebody would clarify it to make sure I don't contribute too much to my account.

The IRS states that the maximum salary that can be used to determine contribution limits is $245,000. Is that before or after calculation of deduction of 1/2 the self-employment tax?

In other words, if someone has an income of $300,000, can they contribute the max of $49,000, or must they compute their salary on $245,000 (which would mean the maximum contribution of around $46,000)?