You've got lots of investment options. But not all of them are created equal. This is especially true when it comes to the SIMPLE IRA and the solo 401k.
The SIMPLE IRA plan is similar to a solo 401k plan. They are both funded by employee deferrals and additional employer contributions.
But there are a few differences you should be aware of. As you can see below.
A SIMPLE IRA plan can be established at a bank, insurance company, or other qualified financial institution by any employer who has less than 100 employees, who will receive at least $5,000 in compensation from the employer in the preceding calendar year.
The SIMPLE IRA plan has a lower deferral limit than a solo 401k. But unlike a solo 401k plan, the SIMPLE IRA plan uses an IRA-style trust to hold SIMPLE IRA contributions for each employee, rather than the a single plan like a 401k Plan or other qualified retirement plan.
The solo 401k plan is an IRS-approved retirement plan, which is suited for business owners who do not have any employees, other than themselves and perhaps their spouse. There are a number of benefits that are specific to solo 401k plans that make them a far more attractive retirement option for a self-employed individual than a SIMPLE IRA.
A Solo 401k Plan includes both an employee and profit sharing contribution option, whereas, a SIMPLE IRA only offers minimal employee deferral opportunities.
Under the 2017 Solo 401k contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $18,000. That amount can be made in pre-tax or after-tax (Roth). On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $54,000.
For plan participants over the age of 50, an individual can make a maximum employee deferral contribution in the amount of $24,000. That amount can also be made in pre-tax or after-tax (Roth).
On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $60,000.
Whereas, a SIMPLE IRA has a lower deferral limit of $11,500 for 2017, plus a $2,500 catch-up contribution. In addition, the employer must provide either a dollar-for-dollar contribution of up to three percent of compensation to all who defer or a two percent non-elective contribution to all employees who are eligible to participate in the plan and who have earned $5,000 or more in compensation from the employer during the year. Hence, a participant in a SIMPLE IRA would be significantly limited in the amount of annual deferrals to be made to the retirement account in comparison to a Solo 401k Plan participant.
With a Solo 401k Plan a plan participant who is over the age of 50 is able to make a catch-up contribution of up to $6,000. Whereas, with a SIMPLE IRA, the maximum annual contribution limit for is just $2,500.
A Solo 401k Plan can be made in pre-tax or Roth (after-tax) format. Whereas, in the case of a SIMPLE IRA, contributions can only be made in pre-tax format. In addition, a contribution of $18,000 ($24,00, if the plan participant is over the age of 50) can be made to a Solo 401k Roth account.
With a solo 401k plan you can borrow up to $50,000 or 50% of your account value, whichever is less. The loan can be used for any purpose. With a SIMPLE IRA, you can't even borrow $1.
With a solo 401k plan, you can make a real estate investment using non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax. However, the non-recourse leverage exception is only applicable to 401k qualified retirement plans and does not apply to IRAs. In other words, using a Self-Directed SIMPLE IRA to make a real estate investment involving non-recourse financing would trigger the UBTI tax.
With a Solo 401k plan, your 401k bank account can be opened at any local bank or trust company. In the case of a SIMPLE IRA or a Self-Directed IRA, a special IRA custodian is required to hold the IRA funds.
With a Solo 401k, the plan itself can make real estate and other investments without the need for an LLC. (Depending on the state you're in, forming an LLC could prove costly.) Since a 401k Plan is a trust, the trustee on behalf of the trust can take title to a real estate asset without the need for an LLC.
A Solo 401k offers greater creditor protection than a SIMPLE IRA. The 2005 Bankruptcy Act generally protects all 401k assets from creditor attack in a bankruptcy proceeding. In addition, most states offer greater creditor protection to a solo 401k qualified retirement plan than a SIMPLE IRA outside of bankruptcy.
Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.
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