Sunday, March 29, 2015

Self-directed IRA or SEP IRA for a Small Business Owner

Its often thought that one of the major disadvantages of being a small business owner is the lack of employer provided benefits. Along with health insurance, the biggest of these benefits is a retirement plan.

However, small business owners have excellent options on the retirement front. You can choose a self-directed IRA or a SEP IRA and cover the retirement side of your benefits quite nicely.

The Advantages of a Self-Directed IRA

With a traditional IRA, you can contribute up to $5,500 to the plan each year ($6,500 if youre age 50 or older), and invest it virtually any way that you want. Investment income earned on the plan is always tax-deferred. And as long as you have no employer-sponsored retirement plan, the full amount your contributions will be deductible from your income.


One limitation that may apply to a small business owner is if he or she has a spouse who is covered by an employer plan. If thats the case, there may be limits on the amount of the contribution that is tax-deductible.

Even if your spouse is covered, you can still take a full deduction up to a modified adjusted gross income (MAGI) of $183,000. You are also eligible to take a partial deduction up to a MAGI of $193,000, after which your contributions will no longer be deductible.

Whether or not your contributions will be deductible, here are some of the major advantages:

Simplicity. An IRA is virtually the easiest type of retirement plan to start and to maintain. You simply fill out some paperwork – often most of it done online – send in your contribution, and go from there. There are no significant paperwork filing requirements on your part, nor are there any involved reporting issues. You can virtually handle it like a bank account, except that its actually a retirement account.

Choice of trustee. Unlike an employer-sponsored retirement plan, where the trustee is a given, you can select any trustee that you want. This can be a bank, a brokerage firm, or even a mutual fund. And as such, you can choose the trustee that offers the lowest fees for the account.

Unlimited investment selection. This is where the term “self directed” enters the picture. Since you are free to choose the trustee that you want, you can choose one that offers any investment selection that you like. And with very few exceptions, you can invest in just about anything you want with a self-directed IRA.

Complete portability. Your IRA is your IRA, and wherever you go, it goes with you. You can move it from one trustee to another, or you can even roll it over into an employer-sponsored 401(k) plan (if that plan permits such a move) in the event that you decide to give up being a small business owner, and decide to take a regular job. 

The Advantages of a SEP IRA

If an IRA is an excellent retirement choice, a SEP IRA is even better - especially for a small business owner. We can think of the SEP IRA as a regular IRA on steroids. It has many of the same advantages, including tax deductibility of contributions and tax-deferred investment earnings. But in almost every other way, the SEP IRA is a superior retirement vehicle.

Here are the specific advantages of a SEP IRA:

Simplicity. SEP IRA is only a little bit more complicated to set up than a traditional IRA.

No limits on the tax deductibility of your contributions. Unlike a regular IRA, you will not lose the deductibility of your contributions even if your spouse is covered by employer-sponsored retirement plan. A SEP IRA is considered to be a retirement plan specifically attached to your business.

Higher Contribution Limits. This is probably the biggest advantage of a SEP over a traditional IRA. Where a traditional IRA is limited to $5,500 per year, you can contribute up to $53,000 with a SEP. You can contribute as much as 25% of your net income (effectively 20%, since your contribution must be based on 25% of your income, reduced by the amount of your SEP contribution). But thats nearly 10 times higher than what it is for a traditional IRA.

Choice of trustees. Like a traditional IRA, you can open up a SEP plan with the trustee of your choice.

Unlimited investment selection. Same as with an IRA, you can invest in just about anything that you want, or that is available through the trustee that you choose the whole the account.

Can extend the plan to cover employees. This is probably the second biggest advantage that a SEP has over traditional IRA. If you have employees, or plan to hire some, you can include them in your SEP plan. Each employee will be required to open up an individual SEP account. This will allow you to begin extending retirement benefits to your employees, which could be an important advantage when it comes to hiring the right people.

Whether you choose a traditional IRA or a SEP IRA, you will not be able to begin making withdrawals from either account until you reach the age of 59 ½. If you do so sooner, the amount of the withdrawals will be subject to ordinary income tax, plus a 10% early withdrawal penalty tax by the IRS.

You will also be required to begin making Required Minimum Distributions (RMDs) from either plan no later than age 70 ½.  But this requirement is one that is imposed on nearly all tax-sheltered retirement plans.

Other than the fact that you will be able to make much larger contributions to a SEP IRA than to a traditional IRA, you cant go wrong with either plan. If you are a small business owner, the only mistake that you can make is to not participate in a retirement plan of some sort. And either of these will be an excellent choice - with the nod going to the SEP.

Author Bio

Donny Gamble Jr. is an online entrepreneur that runs a financial blog called Personalincome.org. He also is a frequent contributor to SmallBizTrends, Huffington Post, and many other personal finance blogs. Follow him on Twitter @donnygamblejr


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