SEP IRA vs Solo 401(k): Which Makes You Rich?

The answer is…it depends!

One nice thing, the government does help you in both types of plans. Uncle Sam, with both the SEP IRA and the solo 401(k) retirement plans, allows your investment in your tax-favored retirement:

1. to be deductible when you invest the money in the plan,

2. grows tax-deferred inside the plan, and

3. suffers taxes only when you take the money from the plan.

Example. You invest $1,000 a month in your retirement. You are in the 40 percent tax bracket (combined federal and state), and you earn 10 percent on your investments. At the end of 30 years, you have $1.58 million in after-tax spendable cash, which comes from (in round numbers):

• $1.2 million in after-tax cash from the retirement plan ($2 million gross less 40 percent in taxes — we’re taking the entire amount out of the plan in this example)
• $380,000 in the side fund (created by investing the $400 of monthly tax savings — $1,000 deduction x 40 percent)

If you had no government help on the taxes and invested $1,000 a month in an investment that earned 10 percent (6 percent after taxes), you would have a little more than $950,000.

Winner. The retirement plan wins by $630,000 — after taxes ($1.58 million vs $950,000).

Okay, that’s the big picture. It tells you that tax-advantaged investing multiplies profits. So, do it.