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What is the difference between a SEP and a 401K?

We have a SEP now for 6 employees. It was set up to maximize the annual deposit. As an employer, we provide 20% of our employee's salary annually. Our goal is to max what we provide ourselves as owners (49,000 for2011).

Does a 401K provide more advantages.

Apr 21, 2012 by Jeff from Ypsilanti Township, MI in  |  Flag
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Jeff- a 401k plan will give you certain benefits compared to a SEP, one of which is that contributions may be made from the first dollar of income (on employee contributions). This can make a big difference in a year where your income is not enough to allow a full contribution, or if your employees are not all high wage earners.

A more significant benefit, however, is that you can establish a ROTH option with many 401k plans. A ROTH option permits you to effectively gross up your retirement plan contribution by the amount of your tax rate. If you are saving for the long term and have a high income and savings rate, the value of the ROTH option is substantial. There are also estate planning benefits, which may be a consideration for you.

Michael makes a good point about defined benefit plans, which you also should consider if you are already taking full advantage of your other retirement plans. You will want to get a defined benefit plan consultant involved at an early stage, so that you and your partners fully undertstand the implications of such an undertaking.

Good luck.

Comment   |  Flag   |  Apr 23, 2012 from San Francisco, CA

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Hi Jeff, the contribution dollar limits for the two plans are the same: $50,000 in 2012. You might save a little on the business expense side by going to a 401k (where the employees make voluntary contributions, thus paying for part of their retirement savings). But if they don't make the maximum contributions they can as a group, the 401k may actually lower how much you can contribute voluntarily as an owner. I'd think the SEP is the better choice for you now if you want to make maximum contributions and the business can afford it for everyone.

If you are older and your employees are generally young/younger (by say an age gap of 15 to 20 years or more), you may want to look at a defined benefit plan. It allows older owners with higher relative salaries to put away big bucks for retirement. Mike

Comment   |  Flag   |  Apr 23, 2012 from Orland, IN

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