Solo 401(k)s and SEP IRAs are both tax-deferredretirement savings accounts for small business owners. (Photo:Getty)

As an owner of a small business, you have multiple roles toplay, and saving for retirement is probably the last thing on yourmind. However, with proper planning, it can minimizetaxes and help make your business profitable.

Solo 401(k)s and SEP IRAs are both tax-deferred retirementsavings accounts for small business owners. The SEP IRA has longbeen a popular choice for self-employed individuals to reduce theirtax bills and save for retirement. However today, solo 401(k) plansare fast gaining popularity.

The extra bit of efforts and cost to open a 401(k) iscompensated for by the opportunity to contribute more money,pre-tax. This article helps you understand these retirementaccounts as well as their pros and cons. Let's take a look:

Solo 401(k)

The solo 401(k) is also known as a sole-participant 401(k). Itis ideal for the self-employed individuals capable of saving morethan the limits of Traditional IRA or Roth IRA retirement accounts.You need to sign a plan adoption agreement and fill out anapplication for which you only require your employer identificationnumber. You must fill out IRS form 5500-SF if your plan has morethan $250,000.

• Your contributions are on a pre-tax basis and the investmentsgrow tax-free. A Roth solo 401(k) is also a good option. It won'treduce your taxable income and you can contribute with after-taxdollars. For qualified withdrawals your earnings will betax-free.
• If you are an employee, you can contribute up to $19,000 inyour solo 401(k) in 2019. You can make additional or catch-upcontributions of $6,000 if you are 50 or above. The total combinedcontributions in 2019 as an employee and employer cannot exceed$56,000 or $62,000 if you are at least 50 years.
• You can also contribute up to 25% of your compensation to yoursolo 401(k) as an employer. Although, in terms of contributionlimit as an employer, compensation worth only up to $280,000 can becalculated.

Advantages and disadvantages

The solo 401(k) has the following pros and cons:

• It's one of the best retirement plans if you are self-employedwith no employees and can afford to save more than $6,000 a year.Besides making bigger contributions as an employee, you can alsomake contributions as an employer.
• If your spouse also earns income from your business, you candouble the amount of your contribution.
• The only disadvantage is the extra paperwork. So considersetting it up only if you intend to make large contributions toit.

SEP IRA

A Simplified Employee Pension (SEP) plan or SEP IRA is ideal forthose who run their own small business with a limited number ofemployees.

• Your contributions are taxed and your investment growstax-free. Your distributions are taxed when you make qualifiedwithdrawals when retired.
• You enjoy much greater contribution limits. In 2019, you cancontribute up to 25% of your compensation with a $280,000 ceilingfor the calculation.
• If you contribute to a SEP IRA for yourself, you are alsorequired to contribute towards the SEP IRA of every eligibleemployee. These employees should be at least 21 years old. Theyshould have worked for you during 3 of the last 5 years and earnedat least $600 from you in the past year. The employer contributionmust match the percentage of compensation which you contributetowards your own SEP IRA.

Advantages and disadvantages

The SEP IRA has the following pros and cons:

•  It allows you to deduct all your employercontributions when calculating your taxes. You can make additionalcontributions to a traditional IRA or Roth IRA for yourself. But,the amount which you can claim as tax-deductible may belimited.
•  Withdrawals before the age of 591/2 are taxed asordinary income and come with a 10% penalty. Once you turn 701/2,you need to start taking Required Minimum Distributions.
•  It can be an expensive choice as you must contributetowards every eligible employee's retirement plan also. In mostcases, employees cannot contribute to their own SEP IRAs.

There is no 'one-size-fits-all solution' to choosing a retirement plan for a small business. While theSEP IRA is easier to open and maintain, the solo 401(k) can allowyou to save more. If you still have any doubts, you can seekprofessional help to make an informed decision.

Rick Pendykoski is the owner of Self DirectedRetirement Plans LLC, a retirement planning firm based in Goodyear,AZ. He has over three decades of experience working withinvestments and retirement planning, and over the last 10 years hasturned his focus to self-directed accounts and alternativeinvestments. Rick regularly posts helpful tips and articles on hisblog at SD Retirement as well as MoneyForLunch, Biggerpocket,SocialMediaToday, WealthManagement, SeekingAplha, andNuWireInvestor. If you need help and guidance with traditional oralternative investments, email him at [email protected] or visit www.sdretirementplans.com.