Solo 401(k) vs. SEP IRA - Which is better for you?
Both the Solo 401(k) and the SEP IRA are designed for self-employed individuals and small business owners who want to fund their retirement, they both have differences, particularly in how contributions are made and the administrative requirements. Here is a short video of regarding the Solo 401k vs SEP IRA.
1. Contribution Structure and Potential
The biggest difference lies in how money gets into the account.
Solo 401(k): This plan allows for dual contributions, meaning you contribute as both the employee (salary deferral) and the employer (profit sharing).
The employee contribution for 2025 is up to $23,500 of your income, which is a fixed amount regardless of your business’s percentage profit.
The employer contribution is an additional amount, up to 25% of your compensation.
This dual structure often allows you to maximize your savings with a lower net income compared to a SEP IRA.
SEP IRA (Simplified Employee Pension IRA): This plan is funded only by the employer (profit sharing) contribution.
The contribution is capped at 25% of your compensation (about 20% of net adjusted self-employment income for a sole proprietor), up to a total maximum of $70,000 for 2025.
Because there is no employee deferral, you need a higher level of compensation to reach the maximum contribution limit.
2. Catch-Up Contributions -Age 50+
This is a major advantage for older business owners.
Solo 401(k): Allows catch-up contributions. If you are age 50 or older, you can contribute an additional $7,500 (or even more if you are age 60–63 in 2025) as an employee deferral, bringing your total potential maximum contribution to $77,500 or higher.
SEP IRA: Does not allow for any specific age-based catch-up contributions because all contributions are made by the employer, not the employee.
3. Setup and Contribution Deadlines
SEP IRA: This plan offers superior flexibility for deadlines. You can establish and contribute to a SEP IRA for a given tax year up until the tax filing deadline of your return, including extensions (typically April 15 or October 15).
Solo 401(k): To utilize the employee salary deferral portion of the contribution for the current tax year, the plan generally must be established by December 31 of that tax year. However, the employer profit-sharing portion can be funded up to the tax filing deadline, including extensions.
4. Administrative Simplicity and Reporting
SEP IRA: This is the most administratively simple plan. It requires minimal paperwork and generally has no annual reporting requirements with the IRS.
Solo 401(k): It is more complex. Once the total plan assets reach $250,000, you are required to file the annual Form 5500-EZ with the IRS.
5. Loan and Roth Options
Solo 401(k): Offers valuable financial flexibility. Many Solo 401(k) plans allow you to take a loan from your account (up to $50,000 or 50% of your vested balance). Furthermore, the employee deferral portion can be made as a Roth contribution (after-tax), providing tax-free growth and withdrawals in retirement.
SEP IRA: As an IRA, it does not allow participants to take loans. While recent tax law allows for a Roth SEP IRA, most major providers do not offer it, meaning contributions are typically pre-tax only.
For examples below, assume a $150k salary/profit. The salary is mostly applicable to the SOLO 401k example.
Contribution Calculation: SEP IRA (Employer Only )
The SEP IRA is funded solely by the employer (profit sharing) contribution, think S Corp or Sole proprietor LLC. For a sole proprietor, the maximum contribution is approximately 20% of your net adjusted self-employment income.
Net Profit: $150,000
SEP Contribution Percentage: 20% of net profit
Maximum SEP IRA Contribution: $150,000 times 20%
Resulting SEP Contribution: ~ $30,000
Conclusion: With a $150,000 profit, your SEP IRA contribution is limited to approximately $30,000.
Contribution Calculation: Solo 401(k) (Employee + Employer)
The Solo 401(k) allows for two contributions, which work together to maximize your savings.
1. Employee Salary Deferral (Remember as an S-Corp you would likely be your own employee)
You can contribute up to $100%$of your income, capped at the annual limit.
Maximum Employee Deferral: $23,500 (2025 limit for under age 50)
2. Employer Profit Sharing
This is added on top of the employee deferral and is limited to approximately 20% of your net profit. Remember, this “Profit Sharing” would be contributed to your own account in the S Corp example, as you are in an employer-employee situation (Employer is S Corp that you own).
Employer Contribution: $150,000 times 20%
Amount: ~ $30,000
3. Total Solo 401(k) Contribution
The two parts are combined, subject to the overall annual limit of $70,000.
Total Contribution: Employee Deferral ($23,500) + Employer Contribution (~$30,000)
Resulting Solo 401(k) Contribution: ~ $53,500
I would recommend to choose the Solo 401(k) if your priority is maximizing contributions at a potentially lower income, having the Roth option, or being able to utilize the loan feature, especially if you are age 50 or older.
Choosing the SEP IRA makes sense if your priority is the simplest admin work and you appreciate the extended deadline for opening and funding the plan. (remember SOLO 401k employee portion must be funded by December 31st each year).
