Solo 401k Vs SEP IRA

Open a solo 401k plan online in under 10 minutes – The Carry Solo 401k Plan is a featured-packed self-directed account that lets you invest in both traditional and alternative assets, take out a loan, or do a mega backdoor Roth conversion with a few clicks.

The solo 401k and SEP IRA are retirement accounts created for small business owners and self-employed individuals. Both have the same contribution limits, offer tax-free compounding on investments, and all business entities are eligible.

A solo 401k offers more tax advantages than a SEP IRA, but has stricter eligibility requirements. Depending on your business, one might make more sense over the other. Let’s take a look at the key differences.

Eligibility Rules

For both the SEP IRA and the solo 401k, you must be a business owner or be self-employed.

‍The only difference eligibility between the two plans is that one is allowed to have employees, and the other is not.

Contribution Limits

The contribution limits for both the SEP IRA and the solo 401k is $69,000 for 2024. However, only the solo 401k has catch-up contributions. If you’ll be at least 50 years old by December 31, 2024, the solo 401k also gives you an additional $7,500 in catch-up contributions for 2024, bringing the solo 401k contribution limit to $76,500. There is no catch-up contribution for the SEP IRA.

The real difference in contributions, however, is not in the limit, but how you’re allowed to contribute.

How You Can Contribute

The contribution limits might be the same, but one of the biggest differences between the two accounts is how you can contribute to your plan.

This creates a significant difference in how much income you need to maximize contributions to either plan. You can max out a solo 401k with less income than a SEP IRA.

Maximizing Contributions

With a solo 401k, because you’re allowed to contribute to your account as both employer and employee, you need less income to maximize your plan than with a SEP IRA.

Remember that the contribution limits are the same for both: $69,000 for 2024.

Employers are allowed to contribute up to 25% of their compensation if the business is incorporated and around 20% if not incorporated. This is the same for both the SEP IRA and solo 401k. However, wth a solo 401k, you can also contribute up to 100% of your income up to $23,000 on the employee side as well.

Also read: Solo 401k Contribution Types

Let’s go through the calculations.

SEP IRAs are only allowed to be contributed with employer compensation. You’re allowed to use up to 25% of your compensation if the business is incorporated.

If you maximize your employee contributions for your solo 401k, you’re left with $46,000 in contribution room remaining to contribute to on the employer side. To maximize contributions on the employer side, you would need to make $174,000 (25% of $184,000 equals $43,500). So, basically, you need $276,000 in income to maximize contributions for SEP IRA and just $184,000 in order to be able to maximize contributions for a solo 401k.

That’s a difference of $92,000 in income required to max out the same contribution limit.

*These numbers are only a simple example and don’t reflect all taxes and deductions for the year.

But that’s not all. It actually gets even more expensive for SEP IRAs if you have employees.

Matching employee contributions rule for SEP IRAs

Remember that a SEP IRA can only be funded by employer compensation. Employees cannot contribute to a SEP IRA.

One of the rules that come along with a SEP IRA is matching contributions for employees.

If you contribute to your SEP IRA, and you have employees in your business, you must contribute the same percentage to your employees’ SEP IRAs as well.

For example, if you decide to contribute 25% of your compensation into your SEP IRA, you must also contribute 25% of each employees’ individual compensations into their SEP IRAs. If you have a lot of employees, it can get really expensive and it might not make sense to have a SEP IRA.

NOTE: You only have to match contributions for employees who are at least 21 years old, worked for you for three out of the last five years, and earned at least $650 for 2022 and $750 for 2023.

Roth option

The SEP IRA and the solo 401k both offer the highest contribution limits out of all retirement accounts. However, one of the biggest distinctions between a SEP IRA and a solo 401k is that the solo 401k has a Roth option, while the SEP IRA does not. A SEP IRA only allows you to contribute to a pre-tax account.

Note: Not all solo 401k plan providers offer a Roth option. You can compare the best Roth solo 401k providers here.

How the Roth option works

With a solo 401k, you contribute as both the employer and the employee. Employer contributions must always be made pre-tax. However, on the employee side, you can choose whether you want to contribute that money into a Roth account or a pre-tax account.

The Roth solo 401k account works similarly to a Roth IRA: You contribute money with after-tax dollars, but you don’t pay any taxes when you withdraw in retirement. The reason why the solo 401k is considered one of the best retirement plans is because the Roth portion of the plan is three times bigger than a Roth IRA. The contribution limit of a Roth IRA account is just $7,000 ($8,000 if age 50+) for 2024. The contribution limit of the Roth solo 401k plan is $23,000 ($30,500 if age 50+) for 2024.

The SEP IRA has no Roth option. You contribute with pre-tax income, get a tax deduction for the year, but you pay taxes when you withdraw from your account in retirement.

Investment options

A SEP IRA only allows investments into traditional assets like stocks, bonds, mutual funds, and ETFs. With a solo 401k, you can invest in virtually any asset class, with few restrictions. In addition to traditional investments, you can also invest in alternative assets like cryptocurrencies, NFTs, precious metals, and private equity.

The only way to invest in alternative assets with a SEP IRA is to open a self-directed SEP IRA.

Withdrawal rules

The withdrawal rules for both the SEP IRA and the solo 401k work the same. You must wait until you’re at least 59½ years of age in order to withdraw from either account. Any early withdrawals are subject to a 10% fee plus income tax on the amount drawn. Both plans have an RMD rule: You must start taking at least the minimum required amount in distributions each year once you reach the age of 73.

Also read: IRA And 401k RMD Table For 2024

The withdrawal tax works a little differently, due to the Roth option of the solo 401k.

The traditional solo 401k and the SEP IRA are both funded with pre-tax income. When you withdraw, you’ll have to pay regular income taxes on the withdrawn amount according to the tax rate at the time and what tax bracket you fall under. However, when you withdraw from the Roth portion of the solo 401k, you don’t pay any taxes on the withdrawals, since you already paid income taxes on your contribution.

Loans

With a solo 401k, you’re given the option to take a loan from your account, while no such option exists with a SEP IRA. You’re allowed to borrow up to 50% of your plan value up to $50,000. Interest rates vary depending on your plan provider, but it’s usually based on the current prime rate plus one or two percent.

While it’s nice to have the option, it can’t really be called a perk or benefit because of the repercussions of taking a solo 401k loan. You’re basically withdrawing money from your retirement account and paying the interest to the government. While the interest rate isn’t terrible, the real damage comes from taking money that would otherwise be compounding for you tax-free in your account.

Still, it’s convenient to have the option. Solo 401k loans are fast, doesn’t require a lengthy application, doesn’t affect your credit score, and you can use the money for whatever you like.

Which one’s better?

For other retirement account comparisons, the answer to this question is usually: “it depends”.

But in this case, if you don’t have any employees and you qualify for both accounts, the solo 401k is almost always the better choice.

Here’s why:

On the bright side, a SEP IRA is much easier to set up than a solo 401k. Not every broker offers a solo 401k plan. And if they do, not every plan offers the full benefits (like a Roth option).

‍If you don’t qualify for a solo 401k, a SEP IRA is a good option for business owners with few employees and a high income. It’s also a quick and easy way to set up retirement plans for your employees. Having automatic contributions to their SEP IRA can also be attractive for potential employees of your business.

Just remember that the SEP IRA has employment contribution matching rules. Whatever percentage you contribute to your SEP IRA, you also have to contribute to every single employee’s SEP IRA as well.

Can you contribute to both a SEP IRA and solo 401k?

Yes. Let’s say you have two businesses – one has employees and the other does not. You would be able to contribute to a SEP IRA for the business with employees, and contribute to a solo 401k for the business with no employees. However, whether you’re allowed to or not depends on how your SEP IRA was formed. Read more about contributing to both accounts here.

	SEP IRA	Solo 401k
Eligibility	Any business owner or self-employed individual with or without employees	Any business owner or self-employed individual with no employees (other than your spouse)
Contribution Limit	$69,000 for 2024	$69,000 for 2024
Employer Contributions	Yes, 25% of compensation (~20% for solo practitioners and single-member LLCs)	Yes, 25% of compensation (~20% for solo practitioners and single-member LLCs)
Employee Contributions	No	Yes, up to 100% of compensation up to $23,000 for 2024
Catch-up contributions	No	Yes, if you’re age 50+, you can contribute an additional $7,500 for 2024
Investment options	Only traditional assets	Traditional assets and alternative assets
Roth Option	No	Yes
Loan Option	No	Yes, up to 50% of plan value up to $50,000
Withdrawal Age	59½ years old	59½ years old