If you make the Solo 401k vs SEP IRA comparison, you’ll notice that both retirement plans offer similar options. Namely, tax-deductible contributions and withdrawals taxed in retirement. That said, one prominent feature sets these two apart — you can contribute money to a SEP IRA account only as an employer.
So which plan should you choose? Keep reading to find out!
What Is Solo 401k
A solo 401k is a retirement account for self-employed individuals and their spouses. This type of 401k allows you to make both employer and employee contributions, giving you the potential to save more for retirement than with other types of retirement accounts.
Solo 401k examples include:
- Owner-only businesses
- Partnerships with no full-time employees
- Spouses who are co-owners of the business
What Is SEP IRA
A SEP IRA is a retirement account for self-employed individuals and small business owners. In short, this type of IRA allows you to make contributions as an employer but not as an employee.
And as a result, your contribution limits are higher than with other types of IRAs, but you won’t be able to take advantage of the tax benefits that come with making employee contributions.
SEP IRA examples include:
- Businesses with one or more employees
- Self-employed individuals
- Independent contractors
SEP IRA vs Solo 401k — The Main Differences
There are several differences between Solo 401k plans and SEP IRAs. For instance, you can’t make employee or catch-up contributions with a SEP IRA. With a solo 401k, you can opt for a Roth option, which is otherwise not available with a SEP IRA.
What’s more, if you need to take money from your SEP IRA before age 59, you may have to pay the penalty and owe income tax. Yet, if you take a loan from your solo 401k, the same rules apply as with traditional 401k loans.
Now, let’s get into more detail via our SEP IRA vs Solo 401k chart:
|Withdrawals Taxed in Retirement
Ease of Use
The SEP IRA is easier to set up and maintain. All you need to do is open an account with a financial institution and fill out a few forms. Conversely, with a Solo 401k, you need to set up a trust, which can be complicated and time-consuming. You also need to file annual reports with the IRS.
So, the winner in this 401k vs SEP IRA showdown is most definitely the latter.
As an employer, you can chip in up to 25% of your salary in both Solo 401k and SEP IRA accounts. The maximum contribution for a SEP IRA plan was $57,000 for the 2020 tax year, and $58,000 for the 2021 tax year, and $61,000 for the 2022 tax year.
If you have a Solo 401k account, you can contribute both as an employer and employee. The limit for employees under 50 is $20,500 for 2020 and 2021. Likewise, the limit for employees older than 50 is $27,000.
Can I contribute to a 401k and a SEP IRA in the same year? Yes, you can. However, only if your Solo 401k and SEP IRA plans are offered by different companies. That said, your contributions will be subject to limitations.
For one, your contributions for a SEP plan mustn’t exceed 25% of your compensation ($61,000 for 2022). Moreover, catch-up contributions do not apply to the money your employer puts in.
When it comes to Solo 401k vs SEP IRA contribution limits, the former takes the cake. Simply because you can add an extra $20,500 as an employee.
For a Solo 401k, contributions have to be made by the end of the year. In addition to that, there are different deadlines for setting up and contributing to a Solo 401k plan depending on how your business is structured:
- If you have a Single LLC or C Corp, your deadline will be April 15, 2023
- If you have a Partnership LLC or S Corp, your deadline will be March 15, 2023
- If you request and receive a tax extension, your deadline will be late September or October 15, 2023
For a SEP IRA, contributions have to be made by the due date of your tax return (including extensions).
Restrictions on Withdrawals
Next, in our SEP IRA vs Solo 401k debate, we’ll talk about withdrawals. If you’re 59 ½ or older, you can take money out of your Solo 401k without getting penalized. However, note that the amount you withdraw might be taxed, depending on which type of account you have.
To avoid paying taxes, you need to have a Roth solo 401k account for at least five years.
With a SEP IRA, you can only withdraw money after you retire or reach age 59½. If you withdraw money before then, you’ll pay a 10% penalty. There are also restrictions on how much money you can withdraw each year.
Which one is better for taxes? We would say the Solo 401k. Namely, with a Solo 401k, you can deduct your contributions from your income, which lowers your taxable income. Conversely, with a SEP IRA, you can’t deduct your contributions from your income.
Solo 401k and SEP IRA: Pros and Cons
Here are the main solo 401k vs SEP IRA pros and cons for a clear outline of advantages and disadvantages:
SEP IRA Pros
- Simple to set up and maintain — all you need is a SEP-IRA form from your financial institution
- Flexible contribution limits — you can contribute up to 25% of your net self-employment earnings (up to $61,000 for 2022)
- Tax deductible — SEP IRA contributions are tax deductible.
SEP IRA Cons
- Limited investment options
- Required distributions at age 70 ½ .
Solo 401k Pros
- More investment options — solo 401ks offer a wider range of investment options than SEP IRAs
- No required distributions at retirement age — with a solo 401k, you can leave your money invested for as long as you want.
Solo 401k Cons
- A lot more paperwork
- Higher contribution limit — while the higher contribution limit of a solo 401k is a pro, it can also be a con if you’re not able to max out your contributions
Which Retirement Plan Is Best for You?
Is a solo 401k better than a SEP IRA? In short, if you’re self-employed or have a small business, the Solo 401k is better. If you’re an employee of a large company, the SEP IRA is an ideal choice.
Additionally, if you’re looking for the highest contribution limits, you should opt for Solo 401k. And if you’re looking for an easier account to set up and maintain, the SEP IRA might be a better option.
Solo 401K vs SEP IRA vs Simple IRA
The answer to which of these three retirement plans is best for you depends on a few factors.
The most important one is whether or not you have any employees. For instance, if you don’t have any employees, the solo 401k is the better option. On the other hand, SEP IRA and Simple IRA are excellent plans for people who have employees.
Solo 401k vs Simple IRA vs SEP IRA Table:
|Who can participate
|Who can contribute
|Employer or entrepreneur
|Employers with 100 or fewer employees and self-employed individuals
|Employer and employee
|Self-employed individuals and small business owners
So, which is the best retirement plan for you? If you can contribute the maximum amount to a Solo 401k, look no further than that.
Conversely, if you have employees and want to offer them a retirement plan with matching contributions, the Simple IRA or SEP IRA should be your prime choice. Keep in mind that with SEP IRA, you can contribute money only as an employer.
Now that you understand the main differences when it comes to the SEP IRA vs 401k debate, you can decide which one is more suitable for your particular business.
Overall, if you’re self-employed with no employees, Solo 401k should be your prime choice. On the other hand, SEP IRA may be a better option if you do have employees.
For any other issues you might have, we suggest consulting with an accountant or financial advisor.
Can you contribute to both a SEP IRA and Solo 401k?
Yes, you can contribute to Solo 401k and SEP IRA if different companies offer them.
However, there are limits to how much you can contribute. Meaning, you cannot contribute more than the total amount employees are allowed to contribute, which is $20,500. You also cannot contribute to both plans at the same time.
Can you convert a SEP IRA to a Solo 401k?
The answer is yes. However, there are some things you need to keep in mind.
First of all, if you have any employees who participate in the SEP IRA, they will no longer be able to do so once you convert it to a Solo 401k. This is because the Solo 401k is only for self-employed individuals or those who own their own businesses.
Secondly, you will need to roll over any existing SEP IRA funds into the Solo 401k. This means that you can’t keep both accounts open at the same time.
What is the main difference between Solo 401k and SEP IRA?
The biggest Solo 401k vs SEP IRA difference is that the former is made for self-employed individuals while the latter is created for small business owners. I.e., if you have a SEP IRA account, you can make contributions only as an employer, not as an employee.