A major part of retirement planning is choosing which type(s) of retirement accounts you want to use to hold your savings and investments. If you’re self-employed, either a solo 401(k) plan or Simplified Employee Pension (SEP) IRA can be an excellent choice.
Both solo 401(k) plans and SEP IRAs are tax-advantaged accounts. However, these accounts have several important differences. When conducting a solo 401(k) vs. SEP IRA comparison, variations can be seen with respect to eligibility, catch-up contributions, loan provisions, and more.
If you’re a self-employed person, these differences can make it difficult to figure out whether a solo 401(k) or SEP IRA makes more sense for you. But don’t worry—we’ve got you covered.
We’ll cover the basics of each type of retirement plan, address the key differences, and hopefully answer your most pressing questions about solo 401(k) plans and SEP IRAs. By the time you reach the end of this article, you should be able to decide which of the two plans is right for you.
Related: Retirement Saver’s Tax Credit: What Is It, How Much, Who’s Eligible + More
What Is a Solo 401(k) Plan?
For a self-employed person, a solo 401(k) is simply an ordinary 401(k) plan that’s generally only available to a business owner with either no employees or just one employee who is a spouse. There are both traditional solo 401(k)s and Roth solo 401(k)s, too.
A solo 401(k) plan operates mostly in the same manner as an ordinary 401(k) plan. However, with a solo 401(k) plan, self-employed people can contribute to their retirement savings with both employer and employee contributions.
YATI TIP: Solo 401(k) plans are sometimes called one-participant 401(k) plans, individual 401(k) plans, or uni-401(k) plans.
What Are the Contribution Limits For a Solo 401(k) Plan?
As noted above, a self-employed individual can contribute to a solo 401(k) account as both an employee and an employer. However, there are separate annual contribution limits for each type of contribution.
For the employee contribution, self-employed people can put up to 100% of their earned income for the year into a solo 401(k) account, but these contributions can’t exceed the annual contribution limit. For 2023, the contribution limit is $22,500. If you’re age 50 or older, you can add “catch-up” contributions of up to $7,500 (for a total of $30,000 for 2023).
YATI Tip: For self-employed people, earned income is equal to net earnings from self-employment, minus one-half of their self-employment tax and retirement plan contributions for yourself.
As for the employer contribution, a self-employed person can stash up to 25% of his or her earned income in a solo 401(k) account each year.
Between employee and employer contributions, self-employed individuals can’t put more than $66,000 in total contributions into a solo 401(k) plan in 2023 ($73,500 if you’re at least 50 years old).
YATI Tip: Beginning in 2025, 401(k) catch-up contributions for people 60 to 63 years old will be allowed up to $10,000 or 150% of the regular catch-up contribution amount, whichever is greater. The $10,000 amount will be adjusted annually for inflation.
Related: Best Roth IRA Account Providers
How Is Money In a Solo 401(k) Plan Taxed?
The taxation of money put into a solo 401(k) account differs depending on whether you set up a traditional solo 401(k) plan or a Roth 401(k) plan.
Traditional solo 401(k) plans
With a traditional solo 401(k), you get a tax deduction from business income for contributions to the account. Money in the account then grows on a tax-deferred basis.
You must pay income tax on withdrawals from a traditional solo 401(k) account. If you take any money out of the account before you turn 59½ years old, you generally owe a 10% early withdrawal penalty in addition to taxes (exceptions to the penalty rules might apply).
When you turn 73, a certain amount of money must be taken out of your traditional solo 401(k) account each year. These mandatory withdrawals are called “required minimum distributions” (RMDs).
YATI Tip: The age when RMDs kick in jumps to 75 starting in 2033. It was 72 before 2023.
Related: Best SEP IRA Accounts + Providers
Roth solo 401(k) plans
There’s no tax deduction for contributions to a Roth solo 401(k) plan. However, rather than earnings growing on a tax-deferred basis, they grow tax-free.
Withdrawals aren’t taxed as long as the account has been established for at least five years and you’re at least 59½ years old. Taxes also don’t have to be paid if you develop a disability or die.
If the five-year rule isn’t satisfied or you’re not yet 59½ years old, any withdrawn earnings are generally subject to income tax and the 10% early withdrawal penalty (contributions are not subject to tax or the penalty).
For 2023, you must take RMDs from solo Roth 401(k) plans once you reach 73 years of age. However, starting in 2024, RMDs will no longer be required from solo Roth 401(k) plans.
Related: Should You Max Out Your 401(k) Each Year or Invest Elsewhere?
What Is a Simplified Employee Pension (SEP) IRA?
A SEP IRA is a tax-deferred retirement plan for small business owners and self-employed workers. You can contribute to a SEP IRA as the employer, but not as the employee.
If you’re self-employed, you make contributions to your own SEP IRA. Business owners with employees must also contribute to each eligible employee’s separate account. Employees can’t contribute their own money to their separate accounts.
A business owner or self-employed person decides how much to contribute to their own SEP IRA and, if applicable, to the separate accounts for each employee. However, contributions can’t exceed the annual limits.
The contribution amount is a percentage of the account holder’s compensation. However, for business owners with employees, the contribution percentage must be the same for all eligible workers. A business owner or self-employed person can change the contribution percentage each year—it can even be dropped to 0% for any given year.
Contributions to a SEP IRA are always fully vested.
What Are the Contribution Limits for a SEP IRA?
For 2023, the contribution limit for a SEP IRA is based solely on the first $330,000 of compensation.
For a self-employed person, the SEP IRA contribution limit for 2023 is 25% of compensation, up to $66,000. As with solo 401(k) plans, a self-employed person’s compensation is equal to their net income from self-employment, minus half of their self-employment tax and their contributions to their own SEP IRA.
How Is Money In a SEP IRA Taxed?
SEP IRA funds are generally taxed the same as funds in a traditional solo 401(k) account. Contributions to a SEP IRA are tax deductible, and earnings in the account grow on a tax-deferred basis.
Income tax applies to amounts withdrawn from a SEP IRA. Withdrawals made before the account holder is 59½ years old are generally hit with a 10% early distribution penalty (although there are exceptions).
RMDs kick in once you turn 73 years old.
Related: SEP IRA vs. Roth IRA: What’s the Difference?
Key Differences Between SEP IRAs and Solo 401(k) Plans
Now that we’ve covered some of the basics for both solo 401(k) plans and SEP IRAs, let’s take a closer look at a few key differences (including for some items not covered in the discussions above).
A handy comparison table is also provided down below to help you understand the main differences between traditional solo 401(k) plans, Roth solo 401(k) plans, and SEP IRAs.
Total Contribution Limits
A solo 401(k) and SEP IRA have the same total contribution limit ($66,000 for 2023). However, if you’re at least 50 years old, the overall limit is $73,500 in 2023 with a solo 401(k) plan.
In addition, with a SEP IRA, the entire limit is based on 25% of compensation. However, with a solo 401(k), the 25% cap only applies to the employer contribution (not to the employee contribution). As a result, a solo 401(k) plan might provide more saving potential for some self-employed people.
Loans
Solo 401(k) plans might offer the ability to take a loan for the lesser of $50,000 or 50% of your account balance. SEP IRAs don’t allow for this.
Effect on Taxable Income
A SEP IRA and traditional solo 401(k) both lower your taxable income every year that you contribute to the account, because you can deduct the contributions.
In contrast, you don’t get a contribution deduction with a solo Roth 401(k). Instead, the tax benefit is that money in the account grows tax-free and you don’t have to pay taxes when you make withdrawals during retirement.
Catch-Up Contributions
Solo 401(k) plans offer catch-up contributions, but SEP IRAs do not.
Roth Accounts
You can have a solo Roth 401(k) account with “after-tax” benefits. However, you can’t have a Roth SEP IRA.
Contribution Source
A SEP IRA only allows employer contributions. Comparatively, a solo 401(k) plan permits self-employed individuals to contribute as both employer and employee.
Required Minimum Distributions
Currently, RMDs are required for all solo 401(k) accounts and SEP IRAs. However, starting in 2024, RMDs won’t be required for solo Roth 401(k) accounts.
| Traditional Solo 401(k) Plan | Roth Solo 401(k) Plan | SEP IRA | |
|---|---|---|---|
| Source of Contributions | Both Employer and Employee | Both Employer and Employee | Employer Only |
| Total Contribution Limits | $66,000 | $66,000 | $66,000; Capped at 25% of Income |
| Catch-Up Contributions | Allowed | Allowed | Not Allowed |
| Deduction for Contributions | Allowed | Not Allowed | Allowed |
| Loans | Allowed | Allowed | Not Allowed |
| Tax on Withdrawals In Retirement | Yes | No | Yes |
| Required Minimum Distributions | Yes | Yes for 2023; No After 2023 | Yes |
Related: How to Use Your HSA for Retirement
Solo 401k vs. SEP IRA: Which Is Better to Have?
For many self-employed people, a solo 401(k) is better than a SEP IRA. While both options have the same overall contribution limit, a SEP IRA doesn’t allow you to contribute more than 25% of your income, which means you might be able to contribute more with a solo 401(k).
A solo 401(k) also allows catch-up contributions (a SEP IRA doesn’t), and you might have the ability to take a limited loan from the account balance (depending on your plan). If you have a solo Roth 401(k), you can take tax-free withdrawals during retirement, which might work better for your overall retirement plan (e.g., if you expect your federal income tax rate to be higher when you retire).
There’s also more flexibility with a solo 401(k). If you’re self-employed, you qualify for either account. However, any business owner who has employees, other than a spouse, will need to choose a SEP IRA.
On the other hand, a SEP IRA might be a better choice if you’re on your own right now, but plan to bring on additional employees in the future (not including a spouse).
Related: What is an IRA and How Does it Work?
FAQs on Solo 401(k) Plans and SEP IRAs
In case you’re still on the fence, here are answers to some additional questions you might have about solo 401(k) plans and/or SEP IRAs.
How Can I Set Up a Solo 401(k) or SEP IRA?
Many of the large online brokers offer solo 401(k) plans and SEP IRAs. Fidelity is an excellent choice for either of these retirement savings accounts. There’s no minimum required to open an account, and there are no annual fees or closing costs. Fidelity also offers $0 commissions for U.S. stock, options, and ETF trades. They provide a large range of investment options, too.
- Fidelity, one of the largest brokers on the planet, offers low-cost investing that includes $0 commissions on U.S. stock, ETF, U.S. Treasury, and Fidelity mutual fund trades.
- Investing with Fidelity opens up access to its zero-expense ZERO line of index mutual funds.
- Put a variety of investing and trading tools to work, including Fidelity's stock research dashboard, stock screener, and Active Trader Pro.
- Very good selection of available investments
- Commission-free trading on stocks, ETFs, U.S. Treasuries, all Fidelity mutual funds and some mutual funds from other fund families
- Above-average options fees
- No futures trading
What Investment Options Are Available With a Solo 401(k) or SEP IRA?
Both types of plans typically offer ample investment options. They differ from a traditional 401(k) in that you usually aren’t limited to just a few investment choices.
What Are the Main Differences Between a Solo 401(k) and an Ordinary 401(k)?
The most significant difference between a solo 401(k) and an ordinary 401(k) is who qualifies for each account. A solo 401(k) is designed for a self-employed person with either no staff or just a spouse as the only employee (some partnerships can also set up a solo 401(k) plan).
Meanwhile, larger businesses of any size can set up ordinary 401(k) plans for their employees, some of which might include a profit-sharing contribution or employer match based on a percentage of an employee’s contributions.
There are also differences in how you contribute, and how much you can contribute. The annual contribution limit for an ordinary 401(k) is $22,500 for 2023, with an extra $7,500 allowed if you’re age 50 or older.
With a solo 401(k), you can make both an employer and employee contribution. So, for 2023, you can contribute $22,500 ($30,000 if you’re at least 50 years old) as an employee, and then add up to 25% of your earned income—you just can’t go over the total contribution limit of $66,000. The high contribution limits are a great selling point for solo 401(k)s.
In addition, investment options for an ordinary 401(k) are typically more limited than what’s available with a solo 401(k).
Can You Rollover a Solo 401(k) Into an IRA?
Yes, you can roll over a solo 401(k) into an IRA.
However, doing so prevents you from taking advantage of the “Rule of 55,” which permits workers who leave their jobs to start taking penalty-free distributions from 401(k) retirement plans once they reach age 55. This rule helps people who need or want to retire early.
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