SEPs are typically good for businesses that do not have employees and/or do not wish to maximize retirement savings and significantly reduce taxable income. While SEPs can be a good choice, they limit how much you can save and how much you can reduce your taxable income by. A SEP can only be as much as 20% of your net earnings, up to a maximum of $55,000 for 2018. While this is better than some other retirement plan options, that might not be enough for high-earners looking to reduce their tax liability and plant the seeds for a comfortable retirement. For more information about SEPs please visit https://www.irs.gov/retirement-plans/plan-sponsor/simplified-employee-pension-plan-sep
A Roth IRA is also a popular retirement account that you fund with post-tax income (you can’t deduct your contributions on your income taxes). After that, all future withdrawals are tax free. Unfortunately, there is no up-front tax deduction for Roth IRA contributions. The Roth IRA program also limits your contributions to $5,500 ($6,500 for catch up contributions) in 2018, making it more challenging to accumulate significant retirement savings quickly. Further, there are income limits on the Roth IRA, so it’s not for everyone. If you’re a young entrepreneur just starting out a Roth IRA might be a good fit. However, if you’re a high income self employed person age 40+ the program might not be right for you. For more information about a Roth IRA please visit https://www.irs.gov/retirement-plans/roth-iras
The Simple 401(k) is a tax-deferred retirement plan for self-employed individuals that offers similar contribution limits to a SEP, but is suitable only for businesses with no employees. This probably isn’t going to do much for high-earners and businesses with employees. For more information about a Simple 401(k) please visit https://www.irs.gov/retirement-plans/choosing-a-retirement-plan-simple-401k-plan
Defined Benefit Plans & Cash Balance Plans, which have been around for decades, are gaining steam for a variety of reasons. First, these plans provide the highest contribution limits amongst qualified retirement plans (as much as $220,000 in 2018), which in turn can provide a large tax deduction while accelerating retirement savings.
Both plans have surged in popularity this year because of the tantalizing new 20% deduction (199A) available to certain businesses with pass through income as part of the new Tax Cuts & Jobs Act. The difference between the two plans is fairly simple.
Defined Benefit plans are typically suited for sole proprietors or businesses without employees.
Cash Balance plans are generally good for small business owners with employees that wish to maximize their own contributions and tax advantage of very large tax deductions without giving up too much revenue to employees.
When combined with a 401(k) profit sharing plan an employer can make even more substantial contributions to themselves.
Interestingly, if you’re employed but and have a second source of income, these plans could be right for you by reducing your tax liability and saving for your retirement. Net/net, Defined Benefit and Cash Balance plans allow you to save 2 or 3 times what a SEP or 401(k) allows.