The transition from traditional employee to business owner is always fraught with tons of questions. As you prepare to launch your Limited Liability Company, you may be wondering what will become of the 401(k) you’ve accrued during your career. You’ve invested years of your life with your current employer, and you certainly don’t want to compromise your financial future when you depart.
Let’s get into your options for leaving your current position, and why a Simplified Employee Pension Individual Retirement Arrangement (or SEP IRA) may be your best route for a self-employed retirement plan.
Self-Employed Retirement: A Financial Crossroads
The decision to leave a job isn’t one to take lightly. Once you make the game-changing choice, you typically have four options of what you can do with your 401(k). To ensure that you have a comprehensive view of the possibilities, we’ll go through each one here.
Let’s get this idea out of the way first, because if you’re under 60 years old, you’ll face a 10 percent early withdrawal penalty to go this route. Yes, you could close your 401(k) and get a check for the sum of your account, but the cost of doing so likely isn’t worth it.
Moreover, you’ll likely be required to pay state and local income taxes on the entire amount. You’ll also be tapping into money that was earmarked for your golden years, cutting off its potential for growth much earlier than planned.
Don’t Touch It
Provided you have more than $5,000 in your account, you may be able to keep your invested funds in their current 401(k) plan. Of course, depending on the interest rate or investment fees, you may be looking for a change.
If that’s not the case, you might consider not tampering with a system that appears to be working. Before you make that call, do a bit of research into alternative accounts where your funds might be able to perform a bit better.
Merge Into a New Plan
Most 401(k) plans will give you the option of transferring your assets into a new plan. For you, this may look different, since your intention is to start your own business rather than simply move on to a new employer.
We’ll discuss shortly how you can take your existing investment and put it into a SEP IRA, but know that it is also possible to start a new 401(k) unaffiliated with your former employer. Again, just do your homework first.
Roll Into an IRA
Lastly, you might choose to roll your existing 401k into an individual retirement account (IRA). Doing so often provides you with additional flexibility to take more control over how you invest your money going forward. You can continue to contribute to your account, choosing from thousands of stocks, bonds and mutual funds to invest in.
There is one potential downside: You aren’t able to borrow from an IRA, but you can use it early under certain circumstances, such as a first-time home purchase.
Why You Should Consider a SEP IRA
If you’re unfamiliar with a SEP IRA, this term refers to a type of traditional IRA specifically tailored to the needs of self-employed individuals and small business owners. You just need freelance income or at least one employee to open one of these accounts, and only the employer (that’s you) can make tax-deductible contributions toward it. In many ways, it functions like a traditional IRA, including the fact that funds are not taxable until withdrawn.
In addition to their simple, inexpensive setup process, SEP IRAs allow a tremendous amount of flexibility for contributions. You can put away as much or as little money as you want in these accounts, depending on your means. The contribution limit for SEP IRAs is often elevated, allowing you to contribute as much as 25 percent of your income or $53,000 (whichever is lower) as of 2019.
As the employer on record, you can choose to contribute to your own SEP IRA or that of all your employees. But perhaps the best application of this account type is for businesses in which you’re the only employee. If this is you, we recommend a SEP IRA even more highly.
A Multiple-Choice Problem
As you look for a 401(k) alternative for business owners, be sure to consider all the factors. In the end, you’ll have to decide for yourself what is the best course of action for you and your emerging business.
How much flexibility do you want from your retirement account? What are your long-term and short-term goals? Once you understand what you want to get out of your self-employed retirement options, you’ll be better equipped to make that happen. Of course, Incfile is here to help you prepare for a prosperous launch and assist you in navigating the business landscape. Our extensive resources make it easier to build your business to last. To learn more about how we can help, check out our website and get started today!