SEP vs 401k?

[elizabethdmd]

I'm a dentist, my husband is an architect, trying to make it on his own by starting his new firm in which he is the only employee (for right now anyway). It is not bringing in much money now, but we are hoping to set up a 401 k and put all allowable income into that and just live off my income. However after speaking to our accountant, she recommended setting up a SEP rather than the 401k, because the SEP would cost us less set up fees (as opposed to the 401 k, it would probably cost more in fees because we have to pay the financial advisor to do it). But our financial advisor insists on the 401k. Here's what the financial advisor says: "I can’t imagine a scenario where the SEP IRA is going to be a better option.  This is actually a very common discussion item with accountants.  5-10 years ago, a SEP would have been a better option but there have been some key updates since then to make the 401(k) a better option.  Most accounts assume that there will be administrative costs to keep a 401(k) in operation but there won’t be any for you since you have no employees.  The key difference is that you will be able to make contributions to a backdoor Roth IRA ($5,500 per year that grows tax free).  You wouldn’t be able to do that with the SEP IRA.  Otherwise, they are very similar accounts.  Exact same investment options, exact same fee structure, etc."

How do I decipher which "expert" to listen to here, our accountant who says SEP or our financial advisor who says 401k?

[spiritrider]

Your accountant is right that you should not pay fees to your advisor, but not that you should use a SEP IRA.

Why do you have to pay fees to an advisor to set up a one-participant 401k. All of the mainstream one-participant 401k plan providers (ETrade, Fidelity, Schwab, TD Ameritrade, Vanguard, etc...) charge no fees to setup or maintain such a plan. The advisor is only there to put their hand in your pocket.

It would make no sense to pay an advisor to pay to setup or even worse commissions or wrap fees to maintain such a plan.

A one-participant 401k allows an employee deferral of up 100% of employee compensation up to the limit. This limit is 2017 = $18K, 2018 = $18.5K, and an additional $6K catchup contribution >= age 50 for both years. It also allows the same employer contribution as a SEP IRA. For the self-employed this is 20% of net self-employment  earnings (net business profit - 1/2 SE tax). For 2017 a one participant can reach the maximum $54K contribution with $180K of net self-employment earnings. A SEEP IRA would require $270K.

Please, please don't tell me you have an Edward Jones advisor or similar parasite.

[Michael Solari]

You can set up a Solo 401k without an advisor. All you really need is an employer identification number which you can get here (https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Apply-for-an-Employer-Identification-Number-(EIN)-Online)

I like Solok's because they provide more flexibility on the contribution. Let's say your husband nets $50k for the year. He can contribute $18k to a SoloK plus a 20% profit sharing portion which means he can get about ~$28k in the plan. SEP IRA only allows of up to 25% of his net income which means his contribution would be a little more than ~$9k. Vanguard has a good calculator tool: https://personal.vanguard.com/us/SbsCalculatorController

[Zaphod]

Even a 401k set up without an advisor has fees that a SEP doesnt though right? I've not looked in years but didnt come across a free setup structure. The other non backdoor roth issue is that its also less paperwork. Sometimes better investment options in a SEP but depends.

Agree on easier to stuff more money in at a lower income with 401k.

[spiritrider]

There are no setup or yearly administrative fees for a one-participant 401k at any of the major mainstream providers. That has been true for many years. Vanguard is the only one I can think of that restricts options over a SEP IRA and that is just the share class.

[jfoxcpacfp]

Your accountant is wrong. Your financial advisor is almost right (far more than your accountant). The only time that a SEP beats a solo-k is when you need to contribute for a year that is already closed. You must set up a 401k by 12/31 of the year for which it applies. You have until the due date of your income tax return, including extensions, to set up and fund a SEP IRA. Since we are in the dead zone between 10/17 and 12/31, you are limited to contributing for 2017 only. That makes the solo-k the clear winner.

See Which is Better: SEP IRA or a Solo 401k?

[elizabethdmd]

nope, no more ed jones! I actually found an advisor through the white coat investor, but I totally understand the push to do some of this on my own.  I guess I'll just ask the financial advisor what he thinks about us setting it up on our own.  Does income matter here? He's basically at less than 20 k for his first year, while I'm more around 350k.

[ajm184]

The thing that struck me from the OP was the business is starting out and though he is solo now it appears they want to grow the business (i.e. hire employees).  The question in my mind is though a solo 401K is the better and more economical approach right now (i.e. year 1), will this be the case by business year 2?  Is the OP willing to potentially establish two different plans within a relatively short amount of time?  Once you get an employee, the OP will need have a different retirement plan than the Solo 401K.

[elizabethdmd]

yes, exactly, his architecture firm now is just him, but at some point he might need to add employees (maybe 1 year, maybe 2 or 3 years...the field of architecture is not as predictable as healthcare).  However while his earnings are low and he has no employees in the immediate future, we wanted to put all his profits into savings.

[litovskyassetmanagement]

elizabethdmd wrote:

I’m a dentist, my husband is an architect, trying to make it on his own by starting his new firm in which he is the only employee (for right now anyway). It is not bringing in much money now, but we are hoping to set up a 401 k and put all allowable income into that and just live off my income. However after speaking to our accountant, she recommended setting up a SEP rather than the 401k, because the SEP would cost us less set up fees (as opposed to the 401 k, it would probably cost more in fees because we have to pay the financial advisor to do it). But our financial advisor insists on the 401k. Here’s what the financial advisor says: “I can’t imagine a scenario where the SEP IRA is going to be a better option.  This is actually a very common discussion item with accountants.  5-10 years ago, a SEP would have been a better option but there have been some key updates since then to make the 401(k) a better option.  Most accounts assume that there will be administrative costs to keep a 401(k) in operation but there won’t be any for you since you have no employees.  The key difference is that you will be able to make contributions to a backdoor Roth IRA ($5,500 per year that grows tax free).  You wouldn’t be able to do that with the SEP IRA.  Otherwise, they are very similar accounts.  Exact same investment options, exact same fee structure, etc.“

How do I decipher which “expert” to listen to here, our accountant who says SEP or our financial advisor who says 401k?

Click to expand...

If you plan to have any staff at all, SEP can only be used for a short period of time, after which it becomes very expensive, so there are scenarios where SEP can be useful.  We typically recommend SEPs in cases when you just started a practice and you have hired staff, and might have a year or two of contributions without including the staff.  You have to be very careful, because the same rules apply to you as to the staff as far as eligibility.  You can then transition to a 401k plan that also includes the staff, provided that your demographics is favorable.  A 401k will not work for practices that have very large and/or older staff, so in that case we typically recommend a SIMPLE IRA.

Operational cost is irrelevant when considering whether to set up a SEP vs. 401k (solo 401k is just as low cost as a SEP if you have no staff), it is the employer contribution cost that should be the major consideration.

Thus once you can't use SEP, but want to set up a 401k, it would be useful to do the analysis comparing your options:

http://www.dentaltown.com//Dentaltown/Article.aspx?i=403&aid=5625

If you are working on your own as an associate or a 1099 contractor, you would be better off with a solo 401k, but if you know for sure that you will be hiring employees, a SEP might be a better 'transition' plan.  So you don't get to do backdoor Roth for a year or two, and you can still make non-deductible IRA contributions in that time and convert later on.

[spiritrider]

If you adopt a one-participant plan at one of the mainstream providers other than Vanguard, you can select the following employee eligibility restrictions:

1. One year of service


2. The term of service must be >= 1,000 hours/year


3. Age >= 21

At a minimum you have one year after hiring an employee. If the person works < 1,000 hours and/or < 21, they are not eligible until they meet these additional requirements.

There is no reason not to adopt a one-participant 401k for 2017. If at some time in the future, you have eligible employees, there is no need to terminate the plan. You find your new small business 401k plan provider and simply amend the current plan to the new plan document and rollover the assets to the new custodian.

The CPA I use occasionally, has had a one-participant 401k for about a decade. He uses a combination of mother's hours and college students for clerical/receptionist duties to stay under the limits. Of course, his wife does all the hiring and cute coeds need not apply.

[litovskyassetmanagement]

spiritrider wrote:

If you adopt a one-participant plan at one of the mainstream providers other than Vanguard, you can select the following employee eligibility restrictions:

1. One year of service


2. The term of service must be >= 1,000 hours/year


3. Age >= 21

At a minimum you have one year after hiring an employee. If the person works < 1,000 hours and/or < 21, they are not eligible until they meet these additional requirements.

There is no reason not to adopt a one-participant 401k for 2017. If at some time in the future, you have eligible employees, there is no need to terminate the plan. You find your new small business 401k plan provider and simply amend the current plan to the new plan document and rollover the assets to the new custodian.

The CPA I use occasionally, has had a one-participant 401k for about a decade. He uses a combination of mother’s hours and college students for clerical/receptionist duties to stay under the limits. Of course, his wife does all the hiring and cute coeds need not apply.

Click to expand...

That's not how it works, unfortunately.  Most TPAs will make you get you a new document.  And solo 401k docs are not going to be handled by anyone that I know. TPAs would handle a doc from another provider and amend it when necessary, but most TPAs would require you to buy their document eventually (unless of course the document was created by the same provider they are using).

So I agree, if no employees, do a solo 401k. However, a SEP would be a better plan if you meet eligibility rules, as it can exclude employees from participation for as many as 2 years.  If you meet 3 out of 5 rule, you can keep a SEP without including staff for 2 years, so that definitely beats a 401k plan where you can only have a 1 year wait period.  So you might end up going from a solo 401k to a SEP and then to a SIMPLE or a full 401k.