Back before we became self-employed, my husband and I each worked for a large company, and we both had 401k accounts. When we quit our jobs, we rolled those accounts over to IRAs, and that has been our retirement savings ever since. In the early days, we didn’t contribute anything at all, but gradually worked our way up to putting the maximum allowable amount into our accounts for the last few years. Although we were happy to be maxxing out our IRAs, we were aware that a lot of people our age have IRAs in addition to employer-sponsored retirement accounts. We incorporated our business four years ago, and considered setting up a retirement plan at the time, but the money just wasn’t there. We were drawing pretty small salaries, and just maxxing out the IRAs was a stretch.
But time has passed and our business has grown, and we decided to revisit the retirement account question. We looked at three options: the Individual 401k, the SIMPLE IRA, and the SEP IRA. The 401k option would have allowed us to contribute a larger amount of money, since the contributions aren’t based on salary (we could each put up to $49,000 into a 401k). The SIMPLE would have allowed us to contribute $11,500 of our salaries, plus up to a 3% match from our corporation. The SEP allows our corporation to contribute up to 25% of our salaries into our accounts.
We debated the relative merits of each option, and discussed it with a representative at Vanguard, where we had decided to open our accounts. The 401k allows the highest contribution, but is also the most complicated to set up and maintain. And neither of us is going to come anywhere near having $49,000 to put into the account. So the higher limit would pretty much be a waste at this point. That narrowed the choice to the SEP or the SIMPLE, and we liked the simplicity of just having the contributions come straight from our corporation, without having to mess with paycheck deductions and contributions from multiple sources. We’re an S corporation, so all of the money our business earns above expenses goes to us one way or another – either by salary or by distributions. Now we’ll just have lower distributions and the the company will put money into each of our SEP IRAs each month – and the company will get a tax write off for doing so.
We’re still working at paying off our mortgage as quickly as possible, and we will continue to max out our IRAs and HSA, and keep contributing to our emergency fund and our son’s college account. With all of that, I think that the restriction on the SEP that limits our maximum contribution to 25% of compensation will be more than enough.
It feels great to be opening our new SEP. We completed all of the paperwork yesterday, and things should be on track for initial contributions in March. After eight years of self-employment, our business is finally starting to be all grown up.
As with any financial ideas that you read on a blog, please don’t think that what works for us is the best option for you. If you’re looking at setting up a new retirement account, do your research and talk with an accountant if you have questions. There are tons of options available, and they vary considerably depending on where you live, where you work, and even the industry in which you work. Also, make sure you compare superannuation funds to see if they’re right for you. There are tonnes out there so make sure you do some research before you commit to any one super fund.
In other news, my article was an editor’s pick in the Festival of Frugality today. Thanks RC!