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Solo 401k vs SEP IRA: Introduction
This guide offers a comprehensive comparison of Solo 401k vs SEP IRA.
As a self-employed individual myself, I can understand how difficult a task it is to plan for my retirement. I mean, firstly, there are no clear options, and secondly, it requires proper research to choose the best-suited option.
While large corporations often offer 401k plans for their employees, many small businesses and freelancers don’t have the same luxury to choose a 401k due to their size.
The good news is that there are retirement plan options tailored specifically for self-employed individuals and small businesses.
In this guide, we will compare two such popular retirement plans: the Solo 401k vs SEP IRA.
Solo 401k vs SEP IRA
Solo 401k
What is Solo 401k:
The Solo 401k, also known as the Individual 401k, is a retirement plan designed for self-employed individuals and small business owners who have no full-time employees other than their spouse or business partners.
It offers attractive features like tax-deductible contributions (traditional Solo 401k option), tax-deferred growth, and the option of tax-free withdrawal (Roth Solo 401k accounts).
The table below presents 10 best solo 401k providers in 2023.
| Best solo 401k providers: Free options (cannot be customized) | |||||
| Best Solo 401k providers | Investment options available | Annual Fees | Setup Fees | Loan availability | Roth option availability |
| E*Trade | A wide range of mutual funds, stocks, bonds, ETFs, and more | Zero | Zero | Yes | Yes |
| Fidelity | A wide range of mutual funds, stocks, bonds, ETFs, and more | Zero | Zero | No | No |
| Charles Schwab | A wide range of mutual funds, stocks, bonds, ETFs, and more | Zero | Zero | No | No |
| Vanguard | A wide range of mutual funds, stocks, bonds, ETFs, and more | Zero | Zero | No | Yes |
| TD Ameritrade | A wide range of mutual funds, stocks, bonds, ETFs, and more | Zero | Zero | No | No |
| Best solo 401k providers: Paid options (self-directed 401k providers-can be customized as per the needs) | |||||
| Best Solo 401k providers | Investment options available | Annual Fees | Setup Fees | Loan availability | Roth option availability |
| My Solo 401k Financial | Stocks, bonds, ETFs and other alternative assets like real estate, precious metals, cryptocurrencies, private equities and other alternative assets | $125 | $525 | Yes | Yes |
| Rocket Dollar | Stocks, bonds, ETFs and other alternative assets like real estate, precious metals, cryptocurrencies, private equities and other alternative assets | Silver: $15 monthly Gold: $30 monthly | Silver: $360 one time setup fee Gold: $600 one time setup fee | Yes | Yes |
| Solo 401k by Nabers Group | Stocks, bonds, ETFs and other alternative assets like real estate, precious metals, cryptocurrencies, private equities and other alternative assets | &99 | $499 | Yes | Yes |
| Safeguard Advisors | Stocks, bonds, ETFs and other alternative assets like real estate, precious metals, cryptocurrencies, private equities and other alternative assets | Yes | Yes | ||
| Ubiquity | Stocks, bonds, ETFs and other alternative assets like real estate, precious metals, cryptocurrencies, private equities and other alternative assets | $19 per month | Zero | Yes | Yes |
Contribution Limits:
The small business owner or the freelancer acts as both an employee and the employer. Hence, the business owner can make contributions both as an employee and an employer.
Contributions you can make as an employee (Elective deferrals)– up to 100% of your compensation (salary or earned income for self-employed individual), up to:
the annual contribution limits of $22,500 in 2023 ($20,500 in 2022; $19,500 in 2020 and 2021), or $30,000 in 2023 ($27,000 in 2022; $26,000 in 2020 and 2021) if age 50 or over; plus
Employer nonelective contributions– 25% of earned income as an employer.
Catch-up contributions: You get an extra up to $7500 contribution, in case you are aged 50 years or more.
Combined employee and employer contribution: Please note that the combined employee and employer contribution for 2023 cannot exceed $66,000 for ages less than 50 and $73,500 for ages 50 or more.
Let’s take an example.
Ben, age 51, earned $50,000 in W-2 wages from his S Corporation in 2023.
Maximum contribution he can make as an employee (elective deferral) is $22,500.
Maximum contribution he can make as an employer is 25% of $50,000, i.e. $12,500.
Since he is of age 51 (>50), he gets a catch up contribution of $7500.
Hence, the annual maximum contribution for Ben in the year 2023 is ($22,500 + $12,500 + $7,500) = $42,500..
When to choose Solo 401k plan:
The Solo 401k plan is an excellent choice under the following circumstances:
- Roth Option: If you want to contribute to a Roth account within your retirement plan, the Solo 401k provides that flexibility. Hence you can have after-tax contributions, which grows tax free, with no taxes on withdrawal.
- Higher Contribution Limits: The Solo 401k allows you to contribute more money towards your retirement compared to the SEP IRA. This is because
- In addition to the contribution you make as an employer, the Solo 401k plan also allows you to make contributions as an employee.
- Furthermore, in case you are 50 or over in age, the solo 401k allows catch up contributions unlike SEP.
- Catch-Up Contributions: As mentioned, if you are aged 50 or older and want to boost your retirement savings, the Solo 401k allows catch-up contributions of 7500 in 2023.
- Loans: The solo 401k plan can also allow you to take loans up to an amount which is the lesser of either 50% of the plan balance or $50,000.
SEP IRA
What is SEP IRA:
The Simplified Employee Pension (SEP) IRA is another retirement plan suitable for freelancers and small business owners, especially when they have a few employees.
The SEP plan is easy to set up as compared to the solo 401k and other retirement plans for self-employed and small businesses.
It allows employers to make tax-deductible contributions to their employees’ retirement accounts, making it an attractive option for providing retirement benefits.
Contribution limits for SEP IRA
In 2023, the contribution limit for a SEP IRA is the lesser of:
- 25 percent of the employee’s compensation or
- $66,000
Unlike the solo 401k, in which you can contribute both as an employee or an employer, SEP IRA plan only allows the employer to contribute.
Unlike the solo 401k, the SEP IRA does not offer a catch up contribution.
When to choose SEP IRA plan:
The SEP-IRA can be a good choice under the following circumstances:
- Employees to Include: If you have employees other than yourself, your spouse, or business partners, solo 401k is not a plan you will be eligible to. In these cases you can opt for an SEP IRA retirement plan.
Simplicity in Contribution: Compared to a 401k (and solo 401k), it is much simpler to contribute to an SEP IRA. There are no such complex forms you need to fill in, as in a solo 401k.
Solo 401k vs SEP IRA: Summarised in a table
| Feature | Solo 401k | SEP IRA |
| Roth option | Available | Not available |
| Contribution limits | Available for people of age 50 or more ($7500 for 2023) | Slightly lower |
| Catch up contributions | Availble for people of age 50 or more ($7500 for 2023) | Not available |
| Plan Administration | More complex | Less complex |
| Loan option | Available | Not available |
Solo 401k vs SEP IRA: Concluding which is better suited for a self-employed and a small business owner
In conclusion, both the Solo 401k and the SEP IRA are effective retirement plans for self-employed individuals and small business owners. However, the choice between the two depends on specific circumstances and preferences.
However, Solo 401k is particularly a good plan if you are a freelancer or self-employed because it gives you extra bandwidth of contribution, which you can make both as an employee and an employer.
Solo 401k is a better option when you are a small business owner in which the only other employee is your spouse or other business partners. It gives you the flexibility of a Roth option, higher contribution limits, and the opportunity for catch-up contributions if you are over 50 years of age.
On the other hand, the SEP IRA is more suitable when you are a small business owner with few eligible employees and wish to provide them with retirement benefits. However, it’s worth noting that as your business grows and you have more employees, the SEP IRA may become less attractive due to the requirement of treating all qualifying employees equally in terms of contributions.
It is essential to consider your unique financial situation, long-term goals, and the growth potential of your business before making a decision. Consulting with a financial advisor can also help you make an informed choice and create a solid retirement plan that aligns with your needs and aspirations
