SEP or taxable brokerage account?

[skyler]

Hello all,
researched the forum for SEP advice, not much out there..

Here is my question:
I am self employed (just me, no employees) and have maxed out contributions to my Traditional IRA for this year already.

Have $2200 that I want to invest. I called Vanguard to open a SEP account but after talking to the rep, I decided to wait a bit.

There is confusion in my mind about the 25% of earnings contribution and the self employment tax that needs to be considered to figure out maximum contributions.

Should I just contribute to our brokerage account (index funds at Vanguard, admiral shares, so low fees) and not worry about the SEP??

[wannabfrugal]

If you are just wanting to invest a single lump sum and not a consistent portion of your earnings, then I'm not sure a SEP is a good fit for what you want to achieve.  As you alluded to, a SEP lets you contribute a % of your earnings every year.

A SEP is a great retirement investment vehicle, that has fewer rules than most, but you do have to follow those rules.

What is your confusion on the self employment tax issue?

Also, here is a basic overview courtesy investopedia: http://www.investopedia.com/university/retirementplans/sepira/

[skyler]

If nothing changes, I anticipate I will have money available next year to contribute to SEP regularly (after I fully fund my Roth)...

[Reido]

Great Question:

I, Personally, think it depends upon what you plan on doing with the money.  If you're going to invest in index funds or ETF's and hold for the long period, I see no point in using the SEP IRA option.  First, I'd consider switching from the fund to the ETF, as these are often more tax efficient, as they will give very very few distributions; if any.  Furthermore, if you use a SEP IRA you are going to save on income tax, but you will have to pay full income tax on distributions from the account when you withdraw.  If you invest in stock ETFs then you would pay capital gains tax rates on your gains and dividends...  There may be a small advantage to the SEP IRA in this case, but you've locked yourself into an illiquid position where you cannot draw from the account without penalty until the age of 59 1/2.  Personally, I wouldn't bother with this option...

Then again - lets say you're going to invest in bonds:  You put the money into the SEP IRA and it grows tax deferred for many years and basically is able to compound.  If you do this in a cash account, you pay income tax every year on the yield, severely limiting or eliminating any growth of capital.  Hands down, the SEP IRA is a the better way to go.

REITS I'd lean towards SEP IRA

Obviously, you'd have muni bonds in a taxable account...

Just my opinion on the matter...  Clearly, your age and strategy will dictate your course of action.

[skyler]

Why not use a solo 401k?

Good question...

It was my understanding that you have to have employees to open one...
Just starter reading on it...
So other than obviously the annual contribution amount, what are the advantages of a 401k?

[frompa]

If your uncertainty goes to determining exactly how much you can put in your SEP, set the cash aside and wait til tax time to make the decision.  You can fully fund your SEP for 2013 up until April 15, 2014.  I've used a SEP as a primary savings vehicle for years, and I most always wait til April to make the final contribution for the preceding year. 

[skyler]

Thanx frompa,

Have you considered a solo 401k at any point???

[kyleaaa]

If you use tax software like Turbotax, it will flat-out specifically tell you how much you can contribute.

First things first: do you pay yourself a SALARY from your business or do you just take all your profit as earnings? You only get to contribute 25% if you pay yourself a salary, meaning you set up payroll and give yourself a W-2 at the end of the year. Otherwise, you can only contribute 20%.

Solo 401k's are a good option and MANY sole proprietors can end up deferring more income than with a SEP IRA, but there is more paperwork to deal with. Still not too bad, though.

[skyler]

If you use tax software like Turbotax, it will flat-out specifically tell you how much you can contribute.

First things first: do you pay yourself a SALARY from your business or do you just take all your profit as earnings?

Taking all profits as earnings here...
Is it wise to open a SEP one year and fund it to max and open a solo 401k and fund it to maximum allowable the next year?

[frompa]

When I set up my SEP, that was the option that allowed me to put the most aside.  Also, as I have employees, I don't think I can do the solo 401(k).  But I've found that the combination of SEP and IRAs has given me enough room to put aside as much tax favored money as I want, from year to year. 

[ioseftavi]

Hello all,
researched the forum for SEP advice, not much out there..

Here is my question:
I am self employed (just me, no employees) and have maxed out contributions to my Traditional IRA for this year already.

Have $2200 that I want to invest. I called Vanguard to open a SEP account but after talking to the rep, I decided to wait a bit.

There is confusion in my mind about the 25% of earnings contribution and the self employment tax that needs to be considered to figure out maximum contributions.

Should I just contribute to our brokerage account (index funds at Vanguard, admiral shares, so low fees) and not worry about the SEP??

I strongly recommend you consider the SEP, or at least SOME type of small business retirement account.  If you are saving for retirement, save in a retirement account.  The government gives varying tax breaks for small business owners saving for retirement.  Don't pass them up without seriously considering them; the money you'll save on taxes will add up to serious change.

Link is from Fidelity, but info applies to all custodians.  Hopefully this helps you sort out what you qualify for.

[skyler]

I spent a bit of time reading on the subject last few days...

Found that Vanguard actually has a nice calculator to help out with allowable portion of SEP contribution:
https://personal.vanguard.com/us/SbsCalculatorController

I also called the IRS and was able to verify the accuracy of my contribution to the SEP for this year.
I opened a SEP with Vanguard yesterday.

As my income grows and I can save more, I may open a solo 401k in the next years to come.

Also,
loved reading this blog, one more reminder why tax sheltered accounts rock long term:
http://www.madfientist.com/retire-even-earlier/