SEP IRA vs. 401K: Choosing the Best Retirement Plan for Your Business

June 6, 2024

In this week’s episode of FIN LYT by EWA, Matt Blocki, Jamison Smith and Ben Ruttenberg dive into a critical decision for business owners: choosing between a SEP IRA and a 401K plan for retirement savings. They begin by outlining the fundamental differences between these two popular retirement vehicles, discussing the ease of setup, contribution limits, and tax implications. Whether you’re self-employed or managing a growing business, understanding these options is vital for your financial strategy.
Matt, Jamison and Ben explore various scenarios to illustrate how each plan works in real-world settings, highlighting the SEP IRA’s suitability for businesses with few or no employees due to its straightforward structure and potentially high contribution limits. Conversely, they discuss the 401K’s flexibility, which allows higher contributions through employee deferrals and employer matching, making it ideal for businesses with more staff.
The episode also addresses complex situations, such as handling high-income earners or businesses with high employee turnover, providing insights into strategic financial planning that can maximize tax benefits while minimizing costs. Tune in for tips to help you make informed decisions about which retirement plan will best support your financial goals and business structure.

Episode Transcript

Welcome, everyone, to this week’s Finlit by UWA podcast. Today we’re talking about very exciting topics. Sep ira versus 401K. If you’re a business owner, which one do you set up? But first, I was gonna say.


I thought were talking about. We’re filming in March here. I thought were talking about fantasy attorney.


Today’s March 14, and Ben’s been getting pretty. He’s just letting us know. He predicted the teams in the Super Bowl. I think he called a golf winner. He’s been getting a little. A little talkative recently, so we’re going to make some predictions here. It’s March 14 against the players championship. I know everyone’s thinking March madness, but I’m really into golf right now, so players championship’s about to happen. Tiger woods is out. He’s not. He’s not playing. But what are your guys picks to win? To win at all? No.


Boy, easy pick is Scotty Scheffler. But that’s not going to be my pick. I just want to shout him out for how well he’s playing. I will select Rory McElroy. I think he’s going to win the players. He’s dealing with a bit of a left miss right now with his irons, but his driver is really on. And this is an awesome course, and he’s won here before, so drive for.


Show, you putt for Dell. So that’s. I’m just saying I’m hoping he gets.


A win and gets some momentum before winning the Masters. I know that’s something that he’s been really working for a long time.


I’m calling. He’s not going to win the.




This players game. He’s not gonna win the Masters. I’m just getting real defensive here against.


Do you have a. Do you have a prediction?


I do, yeah. I’m predicting Joel Damon is not. I’m just 100% speaking. The second whole swing, season two, he’s. He got my heart on season one.


And he, like, just talks about how bad he is.


It’s like, dude, you’re never gonna win season two. I’m just a fan. I’m a permanent fan. And then I’m also a fan right now of Keegan Bradley because of full swing season two, because he didn’t get picked for the Ryder Cup. I think the just. JT played really well. I think they should have picked him for the Ryder cup and he handled it like a pro, like a, just like a. So I’m a keegan. Is Keegan even playing though? Keegan.


Keegan and Joel Damon are playing.


Let’s Joel Damon, let’s make this a little bit more realistic. Will he make the cut? Yes or no?


I’m picking him to win the whole thing.


Okay. All right.


With his bucket hat? Yeah. All right, Jameson, you’ve had plenty of time. I see you’re doing your research there.


Yeah, I don’t know. That’s just a total like, crapshoot. I’m gonna just, you know, I’ll say, let’s see here. I don’t know. I mean, anybody could win this.


We’ll say gotta pick.


It’s JT. JT golfing.


JT is playing.


We’ll take him. You know, he’s due.




And then march Madness predictions. First of all, we’re in Pittsburgh as pit. In or out? Playing Wake Forest today. Must win. You think they’re in?


I think they’re getting in.


I think they’re going to be Wake Forest. I’m sorry. Go ahead, James.


Yeah. I would say if four teams in the ACC will get in there.


Number four right now, unfortunately, Clemson’s going to get in and the Clemson is not. Virginia. Virginia May. I think Pitt’s going to beat Wake Forest. I think they’re going to lose their next game and I think it’s going to be a pretty heartbreaking.


You don’t think they’re going to win?


First four out situation for Pitt, the loss to Missouri early in the year, just aging like milk. They’re like literally the worst. We were at that game together. The only pick game I went to all year and yeah, just a really bad loss and I think it’s going to come back to haunted.


Okay, last prediction then we’ll get the business. Who is going to win it all this year in the NCAA tournament?


Hard to say. I haven’t given it a ton of thought, but I would say of all the teams I watched this year, I think UConn’s the best. So we’ll go with them.


I’m gonna roll with Houston and I don’t know, I don’t have that much college basketball knowledge, like, at all, but, like, I like college basketball, but by no means an expert.


So that’s total guess. I was gonna say Houston, but I want to have. I want to be my own. I wouldn’t have my own pick. I was gonna. Actually, Yukon’s my second point. I definitely can’t agree with Ben after he’s won the last three gentlemen bets we’ve had on sports, so. I don’t know. I’m gonna say Purdue. No, Purdue’s in elude. They’re not even elite eight. They’ll be out. Sweet 16. They’ll be out.


You think?


I have very strong gut feeling. They will be.


Yeah, we’ll have to talk about that.


A team’s gonna get hot, and they’re gonna light up them with threes, and. Yeah, we’ll see. If you remember, they lost to a 16 seed last year, but when Virginia did that, they came back and they won it all.


Yeah, that was kind of what I was gonna say, but you beat me to it.


Okay, I’m gonna pick. I’m gonna pick Unc. I like their point card. Point cards. Really good. Speaking from the heart, just like Joel Damon, you know? All right, we’ll see. All right, back to business. So, Sep Ira versus 401K. So, if I’m a business owner and you guys are my advisor, how. How are you helping me navigate? You know, the Sep versus 400K decision? So give me the. Let’s start with the Sep. Give me the pros and cons. How does it work? When is this a no brainer, and when is this something that. When it kind of comes a gray area.


Yeah. So, a Sep IRA stands for simplified employee pension, purely profit sharing contributions in nature. And one of the big pros for a sep IRA is that it’s extremely easy to set up and to maintain. You could do it. At most, any custodian, quite literally, set up a sep IRA in five minutes. As long as it’s filed before you as a business owner file your tax returns, you can make contributions to it. Traditionally, any SEP IRA contribution has been of the pre tax variety. So any contributions that you make to a SEP are 100% tax deduction. The year in which you make the contributions, that has changed with the Secure act, so there could be a Roth component to your Sep. Again, we’re filming this in March of 2024. A lot of custodians are a little bit slow rolling this out.


It’s an option, but it’s just not an option. Most custodians don’t offer it yet.


It’s legal now. Most custodians are either very slow to adopt this or not offering this yet, but it is technically legal. Starting in 2024, you can make contributions again, if you’re under the age of 50, you can save up to the lesser of 25% of your business revenue, or 69,000 in 2024. So the lesser of those numbers can be saved into a SEP IRA every year.


So let’s give some examples there. So if your business is doing 300,000 of revenue, 25% of that, 75,000.




So you can’t put in 25%. Example, you’re capped at 69,000.


That’s right.


Make a million. 25% will be 250. You can’t put in 250. You can only put in 69,000. But on the flip side of that, if you’re making 100, you can’t put in 69 because it’s. The 25% would be 25,000. So just to make that really clear, 69 is the cap. But also, you can’t go above 25% of your business revenues.


That’s right. Primarily, this would be for business owners that have very few, ideally zero employees or people that are self employed. The reason I say that is because if there are employees, contributions are mandatory and they have to be an equal percentage of what you, as the business owner, put in. So, like you said, Matt, in that example, if you put in 20% of your revenue, you have to put in 20% for all of your employees. So the more employees you have, the more expensive this can be. And generally, we would recommend that.


Let’s run through some case analysis. Let’s just say Ben is the business owner and he makes 200,000. And then let’s say Jameson and I are your employees making 100,000. So if you decide to max it out and put 25% of your 200, that’d be 50,000. You’d also have to put in 25% of 100 for me. And then also 25,000 for Jameson. So that’d be pretty expensive. You’d basically be putting in 50 for yourself, 50 for us. Thank you. Sign me up for that, Ben. Very generous.


Back to my original point. If you have. This is ideally for. If you have zero employees, if you’re self employed, maybe one employee. But again, this is really for the. For the self employed.


Or let’s say you make a million dollars and you have a couple people that just qualify making 10,000. So you can put in. For you to put in the 69,000, it would take 6.9% of your salary or the earnings. And let’s say James and I, in this example are only making 10,000 because we’re like part time workers. We still qualify because the hours, you don’t have to put $690 for us. And if there’s two or three employees, that could become a no brainer. If you have like a huge income and you have a couple employees that make little because they’re part time in that example, then that could become a way to do this again. Because the SeP IRa, I’m like, we’re getting to a Jameson will talk about that. You don’t need a third party administrator.


It doesn’t need it to file a 5500. It’s black or white with how, you know, there’s not these different tests you have to pass to do it. So it’s very easy to administer, but it is very easy to determine if this is a good, that are not for you. And most of the times if you’re a business owner with a lot of employees, it’s just not going to be the right fit. The 401K is the best option. But if you’re a business owner with very little employees and your income is really high, it could be a no brainer. Or if you have high turnover, because as you mentioned, I’m just reading the rules you have in the notes here. What’s the.


Yeah, so that you can exclude part time workers, you can exclude those that are under the age of 21 and then those who have not worked for the employer in at least three of the previous five years, you can also exclude as well. So if you have high turnover employees coming in and out, as long as they haven’t worked at the employer for three of the last five years, you don’t have to make that equal percentage contribution for the SEP as you made for yourself. As the.


Yeah. So like if you have, like if your employees on average stay there two years, a SEP would be pretty cool because you never have to set up the SEP for your. Assuming that you’re trying to solve money for yourself and you’re not generous to your employees, that would be the way to go because then, you know, no one’s there long enough to ever get the funding. So now tell me how. So if you’re doing a pre tax sep IrA, forget the Roth for Roth. Sep for a Sep. For an example. For a lot of high income earners, this gets in the way of a really one of the best strategies I think is out there, the backdoor Roth. So give us a high level, Ben, on why the SEP IRA gets in the way of a backdoor off.


Yeah, we’ll get into this a little bit more when we talk about why the advantages of the solo 401K. But the downside of the SEP IRA is that any money that sits in the SEP is subject to the pro rata rule. So if you wanted to do what’s called a backdoor Roth IRA, if you’re over the income limit to directly contribute to a Rothschild, you want to take advantage of that loophole in the tax code and do a backdoor Roth. Money that sits in a SEP IRA is technically considered for aggregation purposes. So if you do a backdoor Roth, that’s going to count that big SEP IRA balance that you have as taxable. So it kind of defeats the purpose of what you’re trying to do. Whereas money that sits in a solo 401K, it’s not considered an IRA.


So it’s not considered for that aggregation purpose. So you can very cleanly do a backdoor Roth, get that money right now at 7000 in 2024 into the traditional IRA, convert it to Roth the next day, make it basically tax free, whereas in the SEP IRA, that you wouldn’t be able to do it so cleanly.


Gotcha. Okay, well, that. Let’s. Let’s transition to the 401K. So, Jameson, give us the breakdown. How did the 401K works? Pros. And let’s talk about some pros and cons compared to the SEP.


So same limit you can get if you’re under 50, 69,000. But it’s basically dollar for your business income, 1099 income. So if you made 69, let’s say if you made 100,000 in business revenue or 1099 income with a SAP, you’d be capped at $25,000, only 25%, the 401K, you can dollar for dollar. So you get the full 69 real quick.


Break that down for us, because there’s different ways. So let’s assume that you have the elective deferral, the profit share, and then, which is capped at 25%. And then you’re saying you could still get the 69, unlike this HeP. So how would they. Basically three compartments, I think you’re stating, how would we fill those three compartments to get to that 69?


Yeah. So it depends. There’s some variables here. This is solely. This is your only income. You’re just 1099 or business owner. You could do 23,000. Is your salary deferral your 402 g limit? That could be Roth or pre tax. Most of the time, we’re gonna recommend Roth. You could set up a profit share, safe harbor. So then the employer, the business is funding up to 25% like you said. And then you could fill the rest with an after tax contribution and then convert it to Roth. If you have a w two job and a 401k there, and you’re already doing that 402 g deferral 23,000, you can’t do that again. But if you have 100, you thousand of consulting income, you could still get that 66,000.


You could do a profit share, but you could just do an after tax contribution and convert it to Roth and fill it up with.


So we could do 25,000 and then the rest of the 69, would that be 44,000 into the after tax and then convert it to Roth right away?




Awesome. So tons of more flexibility as far as like how easy it is to reach the maximum levels. Awesome. So going through some examples that Ben went through, assuming Ben was the business owner of the 200, we’re each making 100 give us like a high level of how much more economical mean for Ben to fund it to max out for himself, and then also to give what he would need to give to us. So let’s assume he’s making 200,000 in.


A. Oh, the same scenario. Okay, so the 401K.




So the 23,000 we could each defer, that’d be out of our paycheck.


And so first of all, that’s not costing Ben anything because the 401K forces participation in some cases for employees. So the first 23,000, you know, we’re having to do out of our own paycheck doesn’t cost Ben anything. It just money that he was already paying us instead of. It’s going to the 401K, but it’s no new money out to Ben’s pocket.


Yeah. So Ben could do a safe harbor match, then we put that in. He’s going to, let’s say, gives us 3%. So $3,000 each, he takes 3000, says 9000. And then he could decide if you want to do a profit share for us as well. And that could be determined on a year by year basis, depending on how the business is doing. And he could. So we’re at 23 or at three, that’s what, 26, and then that gives us 43 that he could do in profit share if he wanted to.


Yeah. And the cool thing about the profit share here is he could put in for himself, he could structure 10% and then give us. There’s a test. There’s three different ways to pass the test, but you’ve passed a lot of the tests by doing the safe harbor, but he would still need to do some profit sharing for us. But the point is, in the first example, the SEP, if we’re making 100 each, you’d have to put in 25 and 25. With this, we could probably get away where it only cost him like 10,000 each and then still be able to maximize the thing for himself. So in that example, instead of it costing him 50 in employer contribution, it only cost him 20.


Yeah, I just want to clarify. We’re talking about a standard 401K plan here. Solo 401K plan is just for sole props only if you have one employee. We’re more so talking about in that example where maybe an S Corp and I’m the business owner, you’re the employees. I just want to delineate Solo 401K versus.


Yeah, the solo 401K is great because if you’re the only solo 401K would just be solo. Just, you’re the, you know, you’re a doctor. Consulting income, there’s no contributions to anyone else and you can structure however you want in those three compartments. We know Roth versus pre tax to the 402 g profit sharing contribution, then after tax. And you can navigate tax breakage properly. If you want a big tax write off that year of big income, great. No, after tax, go heavier on the profit churn and vice versa. If you’re going to lower tax here, you can do more after tax, convert it to Roth.


I think the one delineation is important. With a sep, there’s no filing every year. It’s just like an IRA that you were to go open with a custodian. Solo 401K, you have to have some plan documents in place to set it up. And then if it’s under $250,000 in plan assets, there’s no annual reporting, but once you hit 250,000, you had to file what’s called a form 5500 with the IR’s every year and so that there is a little bit more accounting and paperwork that needs done. Filing versus a Sep IRA.


Yeah. Then you need a third party administrator to make sure that 5500, or you could do that yourself, but also be nice to have that delegated if you’re busy. Okay, so let’s rapid fire here some pros and cons. So how much income do you need to max out a Sep IRA versus how much income do you need to do a solo 401K, assuming that you’re doing the elective deferral plus the profit sharing contribution?


Yeah. So the 2023, you needed 330,000 of income to fully max out a SeP, but only about 217,000 of income to max out a solo 401K. Just because you’re limited to that 25%, 25% business revenue.


And you’re talking. So again, just to delineate, there’s 25% of business revenue, 20% of sole props. So 2024, just an example. You need 276 revenues to reach the 69,000 versus the 401K. It’s much lower. So the 401K, basically, if you have a lower income, it gives you more flexibility if you want to. If you have the cash flow to max.


That’s right.


So that’s awesome. Okay, so can. So let’s just go rapid fire. So, 401K. Jameson, can you take a look if you needed the money for an emergency, but you were going to put it back, how would we do that? Can you take a loan from it? Can you take a withdrawal from it and then put it back? How does that work?


Yeah, if the plan is set up to allow loans, you can take a loan.


And so pros of that, you avoid taxes, you avoid the 10% penalty. If you’re before 59 and a half. The con is that money that you have loaned out doesn’t participate in market returns. If the market is 10%, you just miss ten. Plus there’s going to be an interest rate that typically follows the fed rate, plus something depending on the custodian. Okay, so it’s an expensive option, but at least if it’s short term, you can take it out and put it back in and avoid those penalties. Sep Ira, then take a loan.


No loan provisions.


No loan provisions. So if we needed the money, we’d have one option. You could do a 60 day rollover. Essentially, you could take the money out of the Sep 60 days, do whatever you want, but you need to get it back into a different SEp within 60 days. If you do that, there’s no. So you could basically do a now that money’s out of the market, but there’s no interest on that. But you have to. You have to do that in 60 days. And you can only do that once every 365 days. So if you’re thinking about doing this, you probably don’t have a good financial plan in place, and you probably don’t have good cash reserves or emergencies in place if that’s your resort that you’re truly falling into. Okay, so we already talked about the backdoor Roth.


Any other considerations that you guys would put on the table here for someone considering the SEP versus the 401K?


Yeah, I would say if you’re older, catch up contributions are allowed in the solo 401K. So you can get an additional 7500 in 2024 if you’re over the age of 50 into a solo 401K, whereas a Sep Ira, you’re still limited to that 69,000. There’s no catch up contributions if you’re above 50.


So if you’re over 50, 76,500 401k, you’re stuck. Still stuck at 69,000. The sep IRA. Awesome. Jameson, how about you? Any last considerations? What about, like, someone only making, let’s say, a doctor’s making half a million at their day job as a w two, and then they start doing, like, legal consulting and they’re only making 20,000. How would you advise them to, how would you advise that person to do a sep versus 400k? When do we determine it’s worth it to go the four one k route, that extra work versus just doing the easy?


It really just depends on, to me, how much they’re saving. So if they’re able to save the full 20,000, then 401K would be a no brainer. And it’s worth it.


Yeah. That’s gonna be consistent in the future every year. If it’s a one time thing, then, yeah, not worth it.


Yeah. And I would say, too, this is, we didn’t discuss this, but from I would advise to, there’s a lot of advisors that recommend simple iras in all of these situations. Most times, those don’t make a ton of sense for a lot of reasons, but if usually a 401K or a sep can be much more beneficial than a simple IRA.


Well, thanks for joining, everybody. Look forward to catching you next week. Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast, and please share with any friends or family members that would also find this beneficial. Thank you very much.

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