Solo 401k vs SEP IRA

A solopreneur has a significant advantage when it comes to retirement planning.  Unlike an employee, a solopreneur has wide latitude with what kind of plan they may use.  They also have the ability to be very generous to themselves or skip the plan altogether, and they may change their minds from year to year.  Two of the most commonly used plans are the Solo 401k and the SEP IRA.  Each has strengths and weaknesses, but by the end of this breakdown you will see that the Solo 401k is the best option for the serious retirement planner.

We will break down six categories and declare the winner in each round.


Contribution limits:

Both plans feature a maximum contribution of $66,000 in 2023, but the Solo 401k allows participants age 50 and older to add an additional $7,500 to their plan.  This is called a catch-up contribution. Winner: Solo 401k



Benefit maximization:

If you have a corporation (or LLC taxed as a corporation), the SEP IRA allows a maximum of 25% of your income to be contributed to the plan.  This means that you must have earned $264,000 to max out your SEP IRA.  In the Solo 401k you are allowed to contribute 100% of your income, up to $22,500.  After that you are subject to the same 25% as the SEP IRA.  This means that you only need $174,000 to max out your Solo 401k.  The contrast is even greater if you have a sole proprietorship.  You need $344,547 to max out your SEP IRA, but you only need $230,520 to max out your Solo 401k.  You can also double these amounts if you have a spouse. Winner: Solo 401k



Tax diversification:

A SEP IRA can only be funded with pre-tax dollars, but a Solo 401k can be funded with both pre-tax dollars and after-tax dollars.  The after-tax dollars (aka Roth contribution) can allow for more creative and flexible withdrawal strategies once you are in retirement.  Since we are unable to know our retirement tax rate ahead of time it is wise to diversify the types of tax treatment across our investment accounts. Winner: Solo 401k



Loan provisions:

It’s simple: Solo 401k allows loans, SEP IRA does not.  If you access your SEP IRA money before age 59 1/2 you will owe income taxes, plus a 10% penalty (unless an exclusion applies).  You can avoid this problem by loaning yourself money from your Solo 401k.  The loan may be up to $50,000 or half of the plan’s investment value, whichever is less.  You must pay yourself back within five years at a reasonable interest rate, but this is far better than credit card or other personal debt.  Just because you can doesn’t mean you should, and don’t set up a Solo 401k with the intention of borrowing from it later.  It is only there as a safety net. Winner: Solo 401k



Admin responsibility:

SEP IRAs require no ongoing paperwork after set-up.  Solo 401k’s do.  For a Solo 401k you must either serve as your own administrator or hire one.  A hired administrator may cost you tens of thousands of dollars over the lifetime of your plan.  Choosing to serve as your own administrator is doable, but you must keep careful records and mark your calendar for regulatory filings due once year (if you plan is worth more than $250,000). Winner: SEP IRA



Establishment date:

A Solo 401k has an earlier establishment requirement than a SEP IRA.  For tax year 2022, a Solo 401k must be established by December 31, 2022, whereas a SEP IRA can be established up until your tax return filing.  If you file an extension for your personal tax return you may wait until October 15, 2023 to set up your SEP IRA. Winner: SEP IRA (since this really only matters once during plan set up I’m giving it a half point)



There you have it.  You can score the result as 4 to 1.5 in favor of the Solo 401k.  The benefits of a Solo 401k far outweigh the minor administrative headache and start-up work.  Do your future self a favor and start a Solo 401k today.

Sherman Asset Management does not provide tax or legal advice.  The information contained herein is provided for informational purposes only.  Do not rely solely upon this information to make tax decisions.