Solo 401(k) Vs Sep IRA: Which Is Best For You?

Solopreneurs have a wide variety of options when it comes to investing and retirement savings, so you’re justified in wondering which is the right choice for you.

A SEP IRA is a common (and popular) way for small business owners to open a retirement account, however, Solo 401(k) plans are also an attractive option. To the novice investor, on the surface the plans seem similar: they are retirement accounts specifically designed for small business owners and both offer tax-deferred retirement strategies. 

But a closer look at the details, contribution limits, and fine print shows they are quite different. 

Which one is right for you? We’ll explore that question and more in this article. Read on to learn more about the differences between a SEP IRA and a Solo 401(k) and see which one is right for you.

What is a Solo 401(k)?

Like an employer-provided 401(k), a Solo 401(k) plan allows you to save for your retirement, invest, and reduce your taxable income. 

A Solo 401(k) is a retirement plan geared specifically toward the unique needs of self-employed individuals and micro-business owners. One of its most appealing features is that it permits an enrollee to wear two contributor’s hats: one as an employee and another as an employer. Under the right circumstances, even the spouse of a participant can contribute to a Solo 401(k) since the spouse of the owner is also considered an owner.  

As of 2023, a Solo 401(k) plan allows you to contribute up to $66,000 and $73,500 if you're aged 50+. Assuming, of course, your income will support the contribution. 

As an employee of your business:

• You can contribute up to $22,500 ($30,000 if you are 50+ years old)

• Your contributions can be pre-tax, Roth, or a mix of the two.

The employee contributions are also called “effective deferral” or “employee deferral”. These function similarly to how you would contribute to a 401(k) plan with your full-time job. 

The limit however is based on all deferrals you make to all plans you participate in combined. 

As an employer (of yourself):

• You can contribute up to 25% of your compensation if your business is incorporated (around 20% if it’s not)

• These contributions are made on a pre-tax basis and capped at $66,000 for 2023

The limit of $66,000 is the combined limit of the employee and employer contributions. 

That is the beauty of a solo 401(k) - because you contribute to both the employee and employer side, you can contribute more than you would to a 401(k) plan of an employer you work for. 

If an individual’s contributions (deferrals and profit sharing) total an amount below the $66,000 limit, an employee can make an additional non-deductible contribution or after-tax contribution to maximize the contribution up to $66,000.  This after-tax contribution however is not like a Roth contribution since the tax-deferred earnings will be taxable upon distribution. 

As an example, Angela is an S-Corporation owner and makes $100,000 of W-2 income for the year.  She is under the age of 50. Her company does not have any employees.  After making the 25% ($25,000) profit-sharing contribution and the maximum deferrals ($22,500), she can make an additional after-tax contribution of $18,000 to get her to the maximum limit of $66,000.  The after-tax contribution cannot be used as a tax deduction.   

What is a SEP IRA?

SEP IRAs are popular for a reason, they have been around for decades and are one of the simplest ways a business owner can invest and save for retirement. 

SEP stands for Simplified Employee Pension Plan (SEP Plan) which contributions are made to, which most individuals call a SEP IRA. A SEP Plan is an employer-sponsored plan in which the contributions are contributed to a Traditional IRA.

You can contribute up to 25% of the business’s revenue (20% for a sole proprietorship) up to the annual limit ($66,000 as of 2023, similar to your profit-sharing contribution to a Solo 401(k).  Employee deferral contributions however are NOT available under the SEP plan. An annual IRA contribution can still be made above and beyond the SEP contribution.   

As an example,  Angela is an S-Corporation owner and makes $100,000 of W-2 income for the year.  She is under the age of 50. Her company does not have any employees.  She established a SEP plan.  The maximum contribution she can make for herself under the SEP plan is $25,000.  Through the SEP IRA, you can then choose what to invest in, whether that be in individual stocks, mutual funds, or ETFs.

What are the differences between a Solo 401(k) and a SEP IRA?

Again, on the surface these plans sound similar: they are retirement plans for self-employed individuals. However, when comparing them side by side there are key differences to be aware of:

  Employer contribution Employee contribution Catch-up contribution? Can you take a loan? Roth contribution The date you need to set up Requirements to operate the plan SEP IRA Yes No No No  Yes (Secure Act 2.0) On or before your tax return due date. Minimal upkeep (though a SEP Plan requires a plan document) Solo 401(k) Yes Yes Yes Yes Yes On or before your tax return due date.  Requires reporting and record-keeping

Advantages of a Solo 401(k)

Solo 401(k) plans offer a host of advantages compared to a SEP IRA. 

Higher contribution limits

For one, you can contribute as an employee of the business as well as the employer which opens the door for more savings (and tax reduction). This is one of the biggest strengths of a Solo 401(k) plan, especially for solopreneurs looking for big retirement savings. Although a proper record-keeping system is needed to administer the plan properly, one of the key strengths of the SEPira(k) platform is its robust record-keeping solution to make managing compliance a breeze.

You can take out a loan

Solo 401(k) plans also support loans that give you quick access to capital whether it’s for business or personal use.  Under the SEPIRAk record-keeping platform, servicing a loan is easy to facilitate and service Read more on how Solo 401(k) loans work. 

Advantages of a SEP IRA

They’re simple

The primary advantage of a SEP IRA lies in its simplicity. 

SEP IRAs are one of the simplest plans to set up as a small business owner, making them a good option for those looking for a plan with minimal upkeep. 

A Solo 401(k) does not always require extensive upkeep though if you manage your plan on the right platform. This is one of the key strengths of the SEPira(k) platform as we offer a robust record-keeping solution to make managing compliance a breeze.

Grows with your business 

Unlike a Solo 401(k), a SEP IRA is not restricted to solopreneurs. You can continue to contribute to your SEP IRA if your business grows, making it a great option for solopreneurs who are looking to scale quickly and rapidly add full-time employees.

Can you have both a SEP IRA and a Solo 401(k)?

Yes, an individual can set up and contribute to a SEP IRA and a Solo 401(k) in the same calendar year. 

The IRS confirmed this IRS Publication 560 (published in 2022), however, the catch is you cannot open a Solo 401(k) if you used the 5305-SEP plan document to establish your plan. In order to maintain a SEP and a Solo 401(k) plan in the same year, you must establish your SEP plan using a prototype document. 

Which should you choose?

Ultimately it comes down to personal preferences. 

If you are a solopreneur with no plans to hire full-time employees (or even any plans within the next several years), then a Solo 401(k) is an excellent option due to the higher limits, loan provisions, and flexibility in what you can invest in.

If you want the simplest plan possible or plan to hire full-time employees then a SEP IRA may be the best option for you.

How to open a Solo 401(k) plan

Opening a Solo 401(k) is easy!

You can create an account in minutes on the SEPira(k) platform to unlock serious retirement savings while letting our platform do the heavy lifting that can make managing a Solo 401(k) easier. 

Create your account and start saving today.