DIY Retirement Savings: SEP IRAs vs. Individual 401(k)s

Are you a free spirit not beholden to a boss who would like to sock away money for retirement in a tax-deferred savings plan that has higher limits than Traditional and Roth IRAs? This blog post is for you. Two fantastic options are the Simplified Employee Pension (SEP) IRA and the Individual 401(k) (aka the Self-Employed 401(k) or the Solo 401(k)). Both of these plans are easy to set up and administer, have high contribution limits, and offer funding flexibility.

The rundown on SEP IRAs:

  • Easy to open: SEPs are offered at most financial institutions that offer retirement accounts.
  • Funding: only by employers, not allowed by employees.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can contribute as much as 25% of your compensation (generally 20% if you’re self-employed[1]), up to $56,000 for 2019.
  • Eligibility: Almost any type of business can offer a SEP. It is best for self-employed individuals and small business owners. An employee is eligible to participate if they are at least age 21, worked for the company in 3 of the last 5 years, and received at least $600 in compensation during the year.
  • If you set up a SEP for yourself, you have to set one up for each eligible employee.
  • If you contribute to your own SEP, you have to contribute the same percentage to each eligible employee’s SEP.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Not allowed.
  • Vesting: Immediate.
  • Administrative considerations: No additional IRS reporting.

The rundown on Individual 401(k)s:

  • Easy to open: Individual 401(k)s are offered at most financial institutions that offer retirement accounts.
  • Funding: only by business owners, in dual role of employer and employee.
  • Funding flexibility: No minimum annual contribution amount. In flush years you can contribute more, in tough times you can scale back.
  • Contribution limits: You can put away more money than with a SEP. This is because you can contribute both as an employee and an employer. As an employee, you can contribute $19,000 ($25,000 if you’re age 50 or older). As an employer, you can contribute an additional 25% of compensation (generally 20% if you’re self-employed), up to a maximum of $56,000 ($62,000 if you’re age 50 or older) for 2019.
  • Eligibility: Business owners who have no employees. This includes sole proprietors, LLCs, S and C corporations, partnerships, and tax-exempt organizations. You must have at least a 5% share in the business. Spouses can contribute if they earn income from the business.
  • Tax benefits: Tax-deferred contributions and investment growth, tax-deductible contributions.
  • Loans: Allowed, but depends on the plan administrator. Generally you can borrow 50% of the account balance, up to $50,000, and take up to 5 years to pay it back.
  • Vesting: Immediate.
  • Administrative considerations: Once your balance reaches $250,000, you have to submit IRS Form 5500 every year.

Both plans allow you to accumulate a formidable nest egg without being subject to the tax consequences of regular brokerage accounts or the low contribution limits of Traditional and Roth IRAs. Start early with smaller amounts and let the magic of compounding interest go to work for you. Or, start later and contribute the maximum possible – with such high contribution limits these plans are perfect for catching up.


[1] Business net profit from your IRS Schedule C, after subtracting out the self-employment tax deduction.

Socially Responsible Investing Comes of Age

For many contemporary investors, portfolio construction goes beyond diversification and asset allocation. At the beginning of 2018, more than a quarter of professionally managed portfolios in the U.S. used socially responsible, sustainable, or impact investing strategies, accounting for $12 trillion in assets overall, according to the Forum for Sustainable and Responsible Investment (also known as US SIF). To the surprise of many, this growing trend is not limited to the millennial demographic, extending across all age groups as more investors seek to align their portfolios with their values.

What is all the excitement about? Here are the three models that generally define the social investment movement:

Socially Responsible Investing
Introduced in the early 1970s, this model of investment was based on screening out or excluding problematic companies from portfolios. Companies were excluded based on their involvement in negatively viewed topics such as weapons, alcohol, tobacco, gambling, fossil fuel production, and so on.

Sustainable Investing
Introduced in the early 2000s, the focus shifted from the exclusion of offending companies from portfolios to the inclusion of companies based on positive screens. These screens are known as ESG screens, which stands for environment, social justice and corporate governance. Positive ESG company profiles can emphasize environmental sustainability, human rights, consumer protections, and diversity, among other issues.

Impact Investing
In 2007, the term impact investing emerged. Impact investing refers to investing in companies that are developing solutions to global sustainability challenges. These challenges include climate change, sustainable agriculture, renewable energy, access to education, affordable housing, and improved health care, among other topics. The impact investing platform also recognizes companies that promote women’s leadership and gender equality, and companies that support community investing, including microfinance services. Notably, these companies also engage in shareholder advocacy and solicit public engagement.

Investors today have more investment choices than ever before, and the dynamic social investment realm is compelling. Investors truly can make a difference by tilting their portfolios toward companies prioritizing the triple-bottom line of people, planet and profit. And the profit component should not be underestimated – since US SIF began tracking the data in 1995, social investments have had a compound annual growth rate of 13.6%. This should prove once and for all that there doesn’t have to be a compromise on returns compared to conventional investments, and depending on the benchmarks, the social investments may even outperform.

For sources, see Bloomberg News.

The Next Generation of Reverse Mortgages

When used appropriately, a reverse mortgage can be an effective tool for managing retirement income. If you are not planning to bequeath your home to beneficiaries, a reverse mortgage can provide an income stream to supplement your cash flow and protect your portfolio during market downturns. In the 80s and 90s, reverse mortgages were often used as a last resort and had a bad reputation due to high fees, overly complex arrangements, and scams. But fast forward to the current day where reverse mortgages are better regulated and insured, and rules are in place to prevent these kinds of abuses. For a senior whose wealth is tied up in an illiquid asset such as their home and who has insufficient income streams to provide a comfortable retirement, then a reverse mortgage could be a great choice.

What is a reverse mortgage? Basically, a reverse mortgage is the opposite of a conventional mortgage. Instead of turning the principal portion of your mortgage payment into home equity, you turn your home equity into money that you can use. A reverse mortgage allows you to borrow against your home equity and receive the proceeds in several ways: a lump sum payment, fixed monthly payments for as long as you live in the home (known as a tenure plan), fixed monthly payments for a term of your choosing (known as a term plan), or a line of credit. You can also combine one of the fixed monthly payment options with the line of credit. The loan balance is due when you die, move permanently, or sell the home.

How does it work? The lender makes a payment or payments to you, and you agree to pay the lender back with the equity you have in your home after you leave the home. Of course, you pay interest on the proceeds, but that interest is rolled into the loan balance. The upshot is as long as you are living in your home, you don’t have to pay anything back. You do continue to be responsible for property taxes, insurance, and home maintenance while receiving the proceeds. This is because you remain the owner, and keep the title to your home. Overall, the reverse mortgage increases your debt and decreases your equity.

An attractive feature of a reverse mortgage is that when it’s time to pay the loan back, you never owe more than the value of your home. If the amount you owe is greater than the value of your home, for example if home prices fall or you live longer than expected, your other assets are protected. In this scenario, the lender is reimbursed by the Federal Housing Administration (FHA) mortgage insurance program that you pay into over the life of the loan. If the amount you owe is less than the value of your home, you or your heirs keep the difference.

Here are the eligibility requirements:

  • 62 years of age or older
  • Own your home outright, or be able to pay off the remainder of your mortgage with the proceeds of the reverse mortgage
  • Occupy your home as a principal residence
  • Must be a single-family home, a two-to-four-unit home where you occupy one unit, a U.S. Department of Housing and Urban Development (HUD)-approved condominium, or a manufactured home that meets FHA requirements
  • Mandatory financial counseling to make sure you understand the risks and process of taking out a reverse mortgage

If you meet the aforementioned criteria and are weighing the pros and cons of various income streams for retirement, it may be worth adding a reverse mortgage to your assortment of options.