Today’s seesaw markets can be worrisome to investors saving for retirement. Watching account values rise and fall can cause you to feel anxious about your simplified employee pension (SEP) plan. However, your SEP has more advantages than disadvantages, even during times of market volatility.
A SEP is a good retirement savings plan. However, rules limit the amount you may contribute. The allowable contribution is 25% of your salary up to a $53,000 maximum. Your employer must contribute the same percentage to its employees' account as it contributes to the employer's account. The percentage contribution limit is fine, but most SEPs are set up for sole proprietors and the self-employed. This creates a con for investors who wish to set aside a larger amount toward retirement but don’t have the income to max out the percentage contribution. These investors have another option.
The solo 401(k) allows for the same contribution of 25% of salary up to a maximum of $53,000 with a twist. You can make an elective deferral of 100% of compensation up to the first $18,000 of compensation, after which the profit-sharing contribution can be made until the maximum is reached. A catch-up provision allows individuals over age 50 to defer an extra $6,000 for a total of $24,000 of initial compensation and a maximum of $59,000. A solo 401(k) also has loan provisions, expanded real estate investing options, a Roth option for the elective referral and better creditor protection.
The top benefit of a SEP is the same as all retirement savings plans. All earnings accumulate with no current income tax obligations. Savings compound at a higher rate, giving you more money after retirement even after future taxes are paid. Contributions are made pre-tax, further increasing the compounding factor.
Most small businesses offer little in the way of pension benefits. An employer making profit-sharing contributions on behalf of its employees is providing a benefit that helps attract and retain quality employees at a lower cost than increasing salary.
Changing Investments Without Tax Liabilities
A SEP is a perfect vehicle if you want to manage a portfolio actively. All trades are made with no tax consequences. You can base decisions on total return and what market conditions dictate. Many SEP providers offer a wide range of investment choices, including inverse exchange-traded funds (ETFs) and stock options that let you profit from volatile markets.
Mutual funds are some of the more common investment vehicles in a SEP account. Savers choose a mutual fund or two and have their contributions deposited on a regular basis. This passive investment strategy is a major pro in the downward stage of a volatile market; dollar-cost averaging automatically takes place. Every deposit purchases a greater number of fund shares as the market goes down and fewer shares as the market is going up. This method of purchasing reduces the average cost per share over time and results in improved profits.
The only real con is not having a SEP or other retirement plan to shield investment profits from taxes. Investors can take advantage of all the pros with minimal account management. If market volatility is driving the market down, shift to conservative investments, such as bonds. If the market starts to rise, shift assets back to stocks. If you don't want to be bothered, pick a no-load asset allocation mutual fund targeted to your retirement goals and let professional portfolio managers make the market-timing decisions. Whether you are an active or passive investor, you will have much larger retirement savings accounts than people who do nothing.