5 Reasons a 401(k) Is Better Than a SEP IRA

Thriving Businesses Rely on 401(k)

The 401(k) plan is one of the most powerful tools a business owner can use to lower their personal taxable income and maximize their savings for retirement. When your business is growing, your team is expanding, and your income is increasing to match, you may find that the SEP IRA you once relied on to put aside some money for the future just isn’t able to keep up. Here are the top five reasons why a 401(k) plan with Fisher Investments can do more for you—and your business—than a SEP IRA.

Save More for Retirement

A 401(k) plan allows employees and the business owner(s) to save more. 401(k)’s that also include a profit sharing option allow for combined employee and employer contributions up to $69,000 a year or $76,500 if age 50 or older.

A SEP IRA limits annual contributions to $69,000 or 25% of your income, whichever is lesser. In fact, you have to make more than $244,000 per year in order to maximize annual savings in a SEP IRA.

A 401(k) can have more plan types added to help you save more when your business is ready. Here’s an example comparing your potential savings with a, SEP IRA, 401(k) with profit sharing and a 401(k) with profit sharing and Cash Balance Plan.

A business owner can save significantly more when they add a Cash Balance Plan to their 401(k). Pair this plan option with your 401(k) to save an extra $409,000 per year above and beyond what a traditional 401(k) allows. In some circumstances, that means you can unlock up to $485,500 per year in tax-deferred retirement savings!¹

Pay Fewer Taxes

A 401(k) plan is leagues ahead of a SEP IRA when it comes to how much money you can save in taxes. With all of the add-ons and optional plan features available, a retirement plan offers one of the biggest tax benefits available for business owners. The tax reduction comes in the form of a pension deduction (the employer contribution and cash balance part of the contribution). It is the only tax-deductible expense business owners can keep. To put this into further relief, this is the only expense business owners can take out of their business’s pocket and put in their own personal pocket—and not pay taxes on it until withdrawn in retirement.

A 401(k) provides business owners three ways to save on taxes:

1. Personal Tax Deduction: Owners can make a tax-deductible contribution to their plan as an employee. Up to 27K a year with catch-up. This deduction comes out of personal taxes.
2. Business Tax Reduction: Then, owners can make a tax-deductible contribution to their plan as the employer. Up to $40,500 with a 401(k) profit sharing plan and up to $409,000 with a 401(k) profit sharing + cash balance plan.
3. Start-up Tax Credit: There are tax credits for setting up your first 401(k). The credit is 50% of the costs to start a 401(k), from a minimum of $500 per year up to $5,500 per year for the first three years. This is also available for SEP and SIMPLE IRAs

Flexible Savings Options

A 401(k) plans allow you and your employees to save with a Roth option as well as the pre-tax option. A SEP IRA allows only pre-tax contributions, no Roth contributions are allowed. For those early in their careers who would rather pay taxes on their retirement savings now when they’re in a lower tax bracket, Roth contributions can be made on an after-tax basis in addition to the standard pre-tax contributions. This is not available in a SEP IRA.

In order for business owners to benefit in a SEP IRA, they will need to provide a proportional contribution to all employees. Everyone (including the owner) must receive the same contribution as a percentage of their income.

This means that for a business owner who makes $250,000 per year, in order to maximize their annual retirement savings in the SEP IRA ($69,000 for 2024) they will need to provide a contribution to all employees equal to 23% of each employee’s compensation. This can become very expensive, particularly if a business has more than a few employees. Contributions in a 401(k) plan are completely flexible, and do not require proportional contributions.

Get a Safety Net

When life happens, sometimes it can make sense to borrow against your retirement savings. If you choose, a 401(k) plan can offer a safety net to employees and owners alike in the form of 401(k) loans. These loans can be used to finance a new business venture, or even provide short-term relief when the unexpected occurs—like the COVID-19 pandemic. SEP IRAs don’t allow loans.

Empower Employees to Save More

In order to save enough for retirement, employers and employees alike will start saving as soon as possible and increase their savings rates over time. SEP IRAs don’t allow employees to save any of their own money. Not only does a 401(k) have much higher contribution limits, but with a 401(k) plan you can select options that will encourage employee saving in ways that SEP IRAs can’t. Auto-enrollment is an optional 401(k) feature that allows the employer to automatically enroll eligible employees into the plan (unless they proactively opt out). This feature makes it easy for employees to save for retirement. Auto-escalation is another optional 401(k) feature that automatically increases employees saving rates over time, helping them easily stay on track for retirement. Neither of these options are available in a SEP IRA.

Learn how Fisher 401(k) Solutions can help you and your employees maximize retirement savings.

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¹Assumes owner is age 70 or older.