The simplest business to form is a sole proprietorship—an unincorporated business entity owned by one person. A sole proprietorship is not registered with the state like an LLC or Corporation, for example. Therefore, the various self-employed plans as generally sponsored in the individual’s name.
While sole proprietorships can have employees, many entities are owner-only businesses. Thankfully there are several retirement plan types that are designed with sole proprietors in mind. Sole proprietors generally require a plan that is cost-effective for a small business, easy to administer, and advantageous from an income tax perspective.
While there are three types (solo 401k, SIMPLE IRA and SEP IRA) of sole proprietor plans, Sole proprietors typically establish a solo 401k plan over the others because it is one stop shop. Each type of sole proprietor retirement plan is discussed here.
Solo 401k Plan Also Known as Owner-Only 401k Plan
A sole proprietor with no employees (other than her spouse) has the option of establishing a solo 401k plan (also known as an owner-only 401(k). While owner-only 401(k) plans have been available since the inception of the 401(k) plan, the self-employed saw no reason to open a solo 401k over a SEP IRA or SIMPLE IRA until the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) was passed. The new law changed the way deferrals are included in determining the employer’s deductible contribution, resulting in higher contribution amounts. Some of the other benefits of the solo 401k over the other types of self-employed plans include the ability for the business owner to process a solo 401k participant loan from the plan as well as the option to make both Roth designation account contributions as well as after-taxa contributions. To learn more about the solo 401k CLICK HERE.
Simplified Employee Pension (SEP IRA) Plan
SEP plans, like profit sharing plans, allow sole proprietors to contribute a large portion of employer income from taxes each year. One of the main differences between a SEP plan and a solo 401k plan is that SEP contributions are made to the sole proprietor’s Traditional IRA rather than to a plan account. However, the SEP IRA does not allow for employee contributions or Roth contributions or catch-up contributions like the Solo 401k does.
Savings Incentive Match Plan for Employers of Small Employers (SIMPLE IRA) Plan
SIMPLE IRA is another easy retirement plan options for sole proprietors. SIMPLE IRA plans allow the sole proprietor to defer her own income, supplemented by a required match contribution. However, the contributions limits are much less than the solo 401k plan, participant loans are not allowed, and neither Roth contributions nor after-tax contributions are allowed.