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Solo 401(k) vs. SEP IRA: Which is Better?

Solo 401k vs. SEP IRA

When self-employed, you have many retirement options to pick from, including the Solo 401(k) or SEP IRA. For many years, self-employed individuals and small business owners relied on the SEP IRA (simplified employee plan). This type of IRA is tax-advantageous and is a good way for the self-employed to save for retirement. But then came the Solo 401(k) plan.

Key Points
  • The Solo 401(k) and SEP IRA are two popular retirement options for business owners
  • If you have full-time employees, you cannot have a Solo 401(k)
  • Overall, the Solo 401(k) is the best option for owner-only businesses

Solo 401(k)

A Solo 401(k) plan is an IRS approved retirement plan suited for business owners who do not have any employees, other than themselves and perhaps their spouse. Also called the self-employed 401(k) and individual 401(k), the Solo 401(k) is not a new type of plan. Essentially, it’s a traditional 401(k) plan that covers one employee.

Solo 401k vs. SEP IRA

Like a SEP IRA, a Solo 401(k) offers the plan participant the ability to contribute up to $76,500 each year, if you are at least age 50. Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) became effective in 2002, an owner-only business had few reasons to establish a 401(k) because the business owner typically received the same benefits by adopting a profit-sharing plan or a SEP IRA.

After 2002, EGTRRA paved the way for an owner-only business to put more money aside for retirement and to operate a more cost-effective retirement plan than a SEP IRA or 401(k) Plan.

There are a number of options that are specific to Solo 401(k) plans that make it a far more attractive retirement option for self-employed individuals than a SEP IRA.

So what exactly are the differences between the Solo 401(k) vs. the SEP IRA? Let’s take a look.

1. Reach your Maximum Contribution Amount Quicker

A Solo 401(k) Plan includes both an employee and profit sharing contribution option. A SEP IRA is purely a profit sharing plan.

Under the 2024 Solo 401(k) contribution rules, a plan participant under the age of 50 can make a maximum employee deferral contribution in the amount of $23,000. You can make this in pretax or after-tax (Roth).

On the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum, including the employee deferral, of $69,000.

For plan participants who are at least age 50, you can make a maximum employee deferral contribution in the amount of $30,500. Again, you can make this amount one of two ways: pretax or after-tax. Then, on the profit sharing side, the business can make a 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum of $76,500.

Contributions with a SEP IRA

Whereas, a SEP IRA only allows for a profit sharing contribution. Hence, a participant in a SEP IRA will be limited to 25% (20% in the case of a sole proprietorship or single member LLC) profit sharing contribution up to a combined maximum of $69,000 for 2024. No employee deferral exists for a SEP IRA.

2. No catch-up Contributions

You can make a contribution of up to $69,000 with a Solo 401(k) plan each tax year. If you’re at least age 50, you can contribute $76,500. However, with a SEP IRA, the maximum amount that you can defer is $69,000 since a SEP IRA does not offer any catch-up contributions.

3. No Roth Feature

There are two retirement saving forms with a Solo 401(k). You can choose pretax or after-tax (Roth). Whereas, in the case of a SEP IRA, you only have the pretax format to make contributions. As a result, you will have to pay taxes when you make a distribution.

4. Tax-Free Loan Option

You have the option of borrowing up to $50,000 or 50% of your account value (whichever is less). You can then use this loan for any purpose, tax and penalty-free. As a small business owner, this can come in handy when you need immediate funding for your business.

However, with a SEP IRA, if you borrow even $1 from the retirement account, you will trigger a prohibited transaction.

5. Use Non-recourse Leverage and Pay No Tax

If you have interest in making a real estate investment, this is yet another reason you should opt for the Solo 401(k) vs the SEP IRA. With your Solo 401(k) plan, you can use non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBIT or UBTI) tax.

However, non-recourse leverage exceptions in IRC 514 apply to 401(k) retirement plans, not individual retirement accounts (IRAs). In other words, a Self-Directed SEP IRA involving non-recourse financing will, unfortunately, trigger the UBTI tax.

6. Open the Account at Any Local Bank

Another advantage of the Solo 401(k) over the SEP IRA is that you can open this retirement plan at any local bank or trust company. Yet in the case of a SEP or a Self-Directed IRA, a special IRA custodian must hold the IRA funds. While you can go to any bank to open a SEP or Solo 401(k), a Self-Directed SEP IRAs and Solo 401(k)s are becoming more popular. These accounts allow you to invest in traditional and alternative investments, such as real-estate, Cryptos, precious metals, private businesses, and more!

However, it is important to note that when exploring a Self-Directed SEP IRA or Solo 401(k), different custodians allow you to purchase different assets. Some Self-Directed SEP IRA or Solo 401(k) custodians only allow you to purchase precious metals or Cryptos. IRA Financial allows you to invest in a wide range of alternative investments that will allow you to diversify your portfolio. Furthermore, it is important to look at a Self-Directed SEP or Solo 401(k)s fee structure prior to opening an account.

Many Self-Directed IRA Custodians charge fees based on your account value or transaction fees. IRA Financial does not charge transaction or account valuation fees. Instead, we use a flat fee, which allows you to do more with your retirement funds.

Learn More: Beginners Guide to Alternative Investments

7. No Need for the Cost of an LLC

Depending on the state of formation, establishing an LLC (limited liability company) can prove very costly. With a Solo 401(k) plan, you can make real estate and other investments without an LLC. Because a 401(k) plan is a trust, the trustee can take title to a real estate asset without the need of an LLC.

8. Better Creditor Protection

Finally, between the discussion of the SEP IRA vs. Solo 401(k), understand that the Solo 401(k) plan offers greater creditor protection than the SEP IRA. The 2005 Bankruptcy Act generally protect all 401(k) Plan assets from creditor attack in a bankruptcy proceeding.

Additionally, most states offer better creditor protection to a Solo 401k qualified retirement plan than a SEP IRA outside of bankruptcy.


Solo 401(k) vs. SEP IRA by IRA Financial Group

No matter which plan you choose, if you are self-employed or a small business owner, it’s important to have a retirement vehicle to create a nest-egg for the future.

But as you can see, the Solo 401(k) has many great features that the SEP IRA simply lacks. This is why it has become the number one choice for the self-employed. For more information about SEP IRAs or Solo 401(k) contact us today! Ready to open your new retirement account? You can do it all through our app, online through our website, or call us directly.

Get in Touch

Do you still have questions about the Solo 401(k) vs. SEP IRA that we didn’t cover in the article? Contact IRA Financial Group at 800-472-0646. We’ll be glad to answer any questions you may have!

Did You Know

Current challenges facing investors range from a pandemic to economic volatility and it can feel overwhelming. But Solo 401(k) and Self-Directed IRA plans can help offset some of the challenges faced by today’s investors by helping diversify your holdings.


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