Unlocking Retirement Wealth: SOLO401k vs. SEP IRA

Planning for retirement is essential in the freelance and solo entrepreneurship world. However, the day-to-day demands of running a business often prevent entrepreneurs from planning for retirement. However, securing your financial future is as important as managing your current business needs.

IRAs and Solo 401(k)s s are popular retirement planning options among many people. But how do you decide which one is right for you?

This guide helps freelancers and solo entrepreneurs understand Solo 401(k) Plans and SEP IRAs for retirement planning. Whether you're experienced or new, knowing these plans is essential for making an intelligent choice about your financial future.

Our primary focus is helping you choose between SEP IRAs and Solo 401(k) Plans. We will examine why a Solo 401(k) is favorable for many. Additionally, we will explore its benefits, limitations, and how it varies from the SEP IRA.

Key Features of SOLO 401k

Eligibility Criteria

SOLO 401k plans are for self-employed people or small business owners without full-time W2 employees except for a spouse.    

Under the Secure Act 2.0, business owners can exclude certain employees. They can exclude any employee under age 21. They can also exclude employees who work less than 1,000 hours a year. This is true if those employees have not worked at least 500 hours in two years in a row ("long-term part-time employees").  

Contribution Limits

The SOLO 401k allows owners to save up to the IRS contribution limits ($66,000 for 2023 and $69,000 for 2024). They even offer additional $7,500 catch-up contributions for people aged 50 and over. Participants can contribute as both employer and employee.

Tax Benefits

SOLO 401k plans offer excellent tax benefits. These include tax-deferred growth and potential tax deductions on contributions. Employee contributions can be made either pre-tax or Roth. They can even be combined with an after-tax mega-backdoor Roth strategy. As a result, they can be a powerful way to both save for retirement while cutting your taxes.  

Key Features of SEP IRAs

A simplified employee pension (SEP) is an individual retirement account (IRA) for self-employed people and small business owners. They are easy to setup and allow owners to save pre-tax (Roth is often not an option).  Unlike 401(k)s, companies fully fund SEP-IRA retirement contributions that vest immediately.

This means employees cannot save more than what the company chooses to contribute. Additionally, each employee must get the same percentage of their pay as a company contribution. This requirement makes SEP IRAs more costly for business owners who want to maximize their savings.

Eligible Employees:

1. Minimum Age: Employees must be at least 21 years old. An employer can set a lower age limit but cannot exceed 21 years of age.
2. Service Requirement: Employees must have performed services for the employer in at least 3 of the preceding 5 years. This means that if an employee worked for the employer for 3 years within the past 5 years, they are eligible to participate.
3. All eligible employees must participate: Employers must allow all eligible employees to participate in the SEP plan without discrimination.

Excludable Employees:

Certain employees do not require coverage under the SEP. You can exclude the following categories of employees from participating:

1. Union Employees Employers can exclude employees with retirement benefits from a collective bargaining agreement from the SEP plan. This applies to employees covered by such agreements.
2. Nonresident Aliens: Employers can also exclude nonresident aliens who did not receive U.S.-sourced income from the employer.
3. Low-Paid Employees: Employers can exclude employees who earn less than $650 a year in 2022. This limit may change in the future due to cost-of-living adjustments.

Contribution Limits

SEPs let you contribute up to 25% of your income (or $69,000 in 2024, whichever is less). If you are self-employed, your income is typically limited to 20% of your net income.  To calculate your annual contributions, the IRS limits your income to a maximum of $345,000 in 2024.   Unlike many 401(k)'s, however, many SEP IRAs do not allow for additional 50+ catchup contributions.  

Tax Benefits

SEP plan contributions are tax-deductible, lowering taxable income and providing tax-deferred growth, benefiting long-term savers.

SOLO 401k: Pros and Cons

Advantages of a solo 401(k) Plan

High Contribution Limits:

One of the most significant advantages of a Solo 401(k) is the high contribution limit. In 2024, you can contribute up to $23,000 of your income to your 401(k). Combining 50+ catchup contributions with employer contributions allows older workers to save up to $76,500 per year in 2025

This limit is significantly higher than most other retirement plans, allowing for accelerated retirement savings.

Pretax or Roth Contributions:

You can contribute to a Solo 401(k) before taxes, which will lower your taxable income for the year. Most Solo 401(k) plans also offer a Roth option, allowing you to contribute after-tax dollars. Roth contributions will grow tax-free, and you won't have to pay taxes when you take your money out at retirement.

401(k) Loans:

Unlike SEP IRAs, Solo 401(k)s allow penalty-free borrowing in certain situations via a 401(k) loan . This provides convenient access to funds when necessary. This gives you access to funds when needed.

Flexible Contributions:

You have the flexibility to adjust contributions based on your business's profitability. This is particularly beneficial for businesses with fluctuating income.

Limitations of Solo 401(k) Plans

While Solo 401(k) Plans offer numerous benefits, there are some limitations to consider:

1. Eligibility Restrictions: These plans are only available to self-employed individuals with no full-time employees other than a spouse. Hiring additional employees may require you to switch to a different retirement plan.
2. Administrative Responsibilities: Managing a Solo 401(k) involves some administrative work, depending on which provider you choose (see our top Solo 401k providers).  However, you can save time and headaches by choosing a Solo 401(k) Provider that integrates with leading benefit platforms designed for freelancers.
3. Contribution Deadlines: Contributions must be made by your tax filing deadline (including extensions). This requires careful planning to ensure you maximize your contributions and tax benefits.

SEP: Pros and Cons

Advantages

SEPs are easy to set up and manage, making them a convenient retirement option for business owners.

Disadvantages

High earners may face limitations on their retirement contributions due to income-dependent contribution limits. Additionally, you may have fewer options to exclude part-time employees. Finally, employees and owners all must receive the same percentage employer contribution. This can make SEP IRAs very expensive for owners that are trying to maximize their personal contributions.

401(k) vs SEP - Comparing SOLO 401k and SEP

Eligibility Differences

Both plans are for self-employed people and small business owners, but the SOLO 401k is only for businesses without employees. Solo 401(k)s may also provide more options for excluding part-time employees.

Contribution Comparisons

SOLO 401k plans may let you save more for retirement than SEPs, making them appealing for those who want to save aggressively.

Tax Implications

Both plans allow for tax-deferred growth, but the SOLO 401k offers more flexibility with loans and after-tax Roth contributions.

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SOLO 401k Investment Options

Stocks, Bonds, Mutual Funds and ETFs

SOLO 401k plans offer a wide range of investment options, including stocks and bonds, providing opportunities for diversified portfolios.

Alternative Investments

Some options even allow you to invest in alternative assets like cryptocurrency and real estate.

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SEP Investment Options

Stocks, Bonds, Mutual Funds and ETFs

Like Solo 401(k)'s, SEPs typically offer a range of mutual funds, allowing for diversified investment strategies tailored to different risk tolerances.

Administrative Responsibilities in SOLO 401k

Plan Management and Administrative Responsibilities for SEP IRAs

Managing a SOLO 401k requires more effort, including keeping up with paperwork and ensuring compliance with IRS rules. However, providers like ForUsAll can take care of the work to help you stay compliant.

FAQs on SOLO 401k vs. SEP

What are the main differences between a SOLO 401k and a SEP?

• SOLO 401k is for self-employed or small business owners without W-2 employees, except for a spouse. Any business size, including self-employed individuals, can use SEP plans. SEP plans can be quite expensive for owners looking to maximize their contributions. Essentially, every eligible employed person needs to receive the same company contribution rate.
• Contribution Limits: SOLO 401k has higher contribution limits as it allows contributions both as an employer and an employee. SEP contributions are limited to a percent of income.
• Loan Options: SOLO 401k plans may offer loan options, whereas SEP plans do not.
• Administrative Responsibilities: SOLO 401k plans typically require more paperwork and ongoing management compared to the simpler SEP plans.

Can I contribute to both a SOLO 401k and a SEP in the same year?

• You can contribute money to both a SOLO 401k and a SEP in the same year. However, the total amount you contribute must not exceed the IRS limits for retirement accounts. Consult a tax professional to understand how contributions to both plans impact your taxes.

How do the tax benefits of SOLO 401k and SEP plans compare?

• Both plans offer tax-deferred growth, meaning you don't pay taxes on earnings until you withdraw the funds. Contributions to both SOLO 401k and SEP plans can be tax-deductible, reducing your taxable income. SOLO 401k plans have a Roth option. Contributions are made after taxes, but withdrawals in retirement are tax-free.

Are there any loan provisions in SEP plans similar to SOLO 401k?

• No, SEP plans do not have loan provisions. SOLO 401k plans let people borrow from their retirement savings in specific situations, which is special.

What are the investment options available in SOLO 401k and SEP plans?

• Both SOLO 401k and SEP plans have various investment choices like stocks, bonds, mutual funds, and ETFs. SOLO 401k plans may also offer the option to invest in real estate and other non-traditional assets.

How do I decide which plan is better for my retirement goals?

• The decision depends on several factors, including your business structure, income level, retirement goals, and willingness to manage administrative tasks. A SOLO 401k might be better for those seeking higher contribution limits and loan options. A SEP plan could be more suitable if you prefer simplicity and don't mind contribution limitations. Consulting with a financial advisor to determine the best plan for your specific situation is advisable.

Conclusion: Final Thoughts on SOLO 401k vs. SEP

In summary, both SOLO 401k and SEP plans have benefits and can help reach retirement goals. Individuals should base their choice on their financial situations, business structures, and long-term objectives. By understanding the nuances of each plan, you can make an informed decision that aligns with your retirement vision.

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