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SEP IRA vs Self Directed IRA: Which is better?

Most small business owners worry about financial security since they are not covered under an employer-sponsored retirement plan. However, with the improvements in IRA plans over the years, it has now become possible for small business owners to secure their life post-retirement with customized financial products.

Today, small business owners can invest in IRA plans that are designed to meet their unique requirements for the future, like:

  • Self-Directed IRAs – A self-directed IRA gives you a lot of freedom regarding your investment options. It lets you save money that can be used during retirement. With a self-directed IRA, you have complete checkbook control over how you select and manage your IRA investments.
  • SEP IRAs – SEP IRA is very similar to self-directed IRA and has many of the same features, but the difference is that it is more specifically designed for small businesses, with similar but bigger advantages. These accounts do not have any administrative costs for individual employees, and contributions can be made in the same way as any other IRA.

As with traditional IRAs, both of these accounts do not permit you to make withdrawals until you reach the age of 59 ½ years, with early withdrawals being subject to income tax as well as a 10% IRS penalty tax. You also need to start making RMDs (Required Minimum Distributions) when you reach the age of 70 ½ years, the same as with any other tax-sheltered retirement plan.

SEP IRA vs Self Directed IRA

Self-Directed IRAs and SEP IRAs share many advantages but have small differences that you should take into account. Let’s look at the advantages these IRAs share, to understand how they work:

  1. They are Simple and Straightforward – Self-directed IRAs and SEP IRAs are some of the simplest types of IRA accounts you could invest in. To set them up, you just need to fill out the required paperwork and submit your contribution. They tend to work more like a normal bank account, with the only difference being that these are retirement accounts.
  2. Tax-Deferred Retirement Savings – If you are making contributions to either IRA, then you do not have to pay taxes on that amount. This means you can save money on taxes right from the start. For example, if your income is $20,000 and you contribute $2,000, then you only have to pay tax according to $18,000. The earnings from these plans are also tax-deferred, for maximum financial growth.
  3. You Can Pick your Custodian – Many employer-sponsored retirement plans include a specific trustee, which you cannot change. Due to the immense freedom afforded by a self-directed IRA or SEP IRA, you can choose your own custodian, picking one with the lowest fee or one whose services suit you the best.
  4. Freedom of Investment Selection – Self-directed IRAs and SEP IRAs allow you control over the type of trustee you want, which also opens up more investment options. You can select a custodian with investment selections based on your particular requirements. Moreover, with this freedom, you can invest according your needs while enjoying the same tax advantages as a traditional IRA offers.

In addition, there are some specific advantages that each plan offers, which we’ll look at below:

Specific Benefits of Self-Directed IRAs

  • These Accounts are Highly Portable – A self-directed IRA is a completely “personal” oriented account, it stays with you where you want. You can transfer it between custodians and most importantly it can be rolled to employer-funded accounts if you choose to take a regular job instead of continuing with your business in the future.
  • They Offer Greater Protection – Self-Directed IRAs let you user real estate or precious metals to protect your investment from inflation and economic fluctuation. These accounts are very diverse and protect you from market volatility as well as growing your retirement savings.

Specific Benefits of SEP IRAs

  • No Tax Deductibility Limits – With other IRA accounts, you have limitations if your spouse also has an IRA plan, but with an SEP IRA, you will not lose deductibility on contributions even if your spouse has an employer-supported IRA. This type of IRA is designed specifically for you and your business.
  • High Contribution Limits – One of the greatest advantages of an SEP IRA is that it is not limited to $5,500 in contributions per year, and you can contribute much more if you’d like. The limit for an SEP IRA is 25% of your net income up to $53,000, and the percentage of income that you can contribute is almost 10 times higher than traditional IRAs.
  • Cover for Employees – Another major advantage with SEP IRAs is that if you own a business with employees working under you, then your SEP IRA can also be extended to cover your employees if they open up individual SEP accounts too. Other than the fact that this works as a great benefit for existing employees, it can also be a major plus point when you’re attempting to hire new ones.

There are many similarities between both these accounts, but the big difference is that you can make much larger contributions to an SEP IRA as compared to self-directed IRAs. Both plans offer many advantages for individuals and business owners, but an SEP IRA offers considerably greater benefits for those who own a small business.