- Solo 401(k)s and SEP IRAs are for self-employed and small-business owners to save for retirement.
- Solo 401(k)s and SEP IRAs offer growth capabilities and tax advantages for retirement savings.
- The main difference between SEP IRAs and solo 401(k)s is eligibility and benefits.
Self-employed individuals and small business owners face unique challenges when planning for retirement. Solo 401(k)s and SEP IRAs are two popular retirement savings options designed for this group of people to grow their savings through comprehensive retirement planning.
SEP IRAs and solo 401(k)s are two of the best retirement plans for small business owners to save for retirement and receive an initial tax break by deferring a portion of their income each year.
Here is a deeper look into retirement plans for small business owners and how solo 401(k) plans and SEP IRAs compare.
Introduction to solo 401(k)s vs. SEP IRAs
Importance of choosing the right plan
Choosing the right retirement plan for your business is essential for maximizing your retirement contributions. When comparing plan types, consider factors such as tax implications, contribution limits, withdrawal rules, and investment options. Understanding eligibility requirements and administrative burdens helps you select the plan that best suits your business needs.
Solo 401(k)s and SEP IRAs offer unique advantages. It's crucial to thoroughly research and compare these plans to determine the best fit for your business and employees.
Overview of solo 401(k) and SEP IRA
SEP IRAs and solo 401(k)s are robust retirement savings vehicles for small businesses and self-employed individuals. While these two plans cater to similar workers, there are key differences between the two plans, including eligibility, income limits, and plan benefits.
Overall, a solo 401(k) is the stronger option due to higher contribution limits and loan flexibility. However, if you have employees (excluding a spouse), you can't qualify for a solo 401(k) and should consider a SEP IRA instead. But don't fret: SEP IRAs also offer worthwhile benefits and money-growing capabilities.
The best retirement plan for self-employed folks depends on business needs, financial goals, and circumstances. If you're struggling with the best choice, consult a financial planner about your situation for professional insight and guidance.
What is a solo 401(k)?
Definition and purpose of solo 401(k)
A solo 401(k), or one-participant 401(k), is a tax-advantaged retirement plan for small business owners without employees other than a spouse. Similar to a traditional 401(k) plan, a solo 401(k) plan allows participants to defer tax on a portion of their income each year up to the annual limit.
Money in a solo 401(k) can be invested in stocks, bonds, ETFs, and other retirement funds. Funds also grow steadily over time due to compound interest. In most cases, you can't withdraw funds until you're at least 59½.
Eligibility requirements
To qualify for a solo 401(k), you must be self-employed and have no employees. You can't be eligible for a solo 401(k) even if you only have one employee. As long as you meet that requirement, you can open a solo 401(k) plan regardless of age or income.
Contribution limits
Solo 401(k)s follow the same rules for contribution limits, withdrawals, and penalties as traditional and Roth 401(k)s. The main difference is that the business owner acts as both the employer and employee, which allows for two types of contributions.
- Elective deferrals: These can be up to 100% of compensation or earned income (your net earnings after deducting half of your self-employment tax and contributions for yourself if you're self-employed) so long as it falls below the annual limit. You can contribute $23,500 in 2025. That limit is $23,000 in 2024. Catch-up contributions are $7,500 for both years.
- Employer non-elective contributions: Solo 401(k) contribution limits include employer non-electives, which can be up to 25% of compensation for small-business owners. For self-employed people, this contribution is based on a special computation that uses earned income. Total contributions from elective and employer nonelective sources cannot exceed $70,000 in 2025, a $1,000 increase from 2024.
Starting in 2025, employees aged 60 to 63 qualify for a higher catch-up contribution limit of up to $11,250 instead of the $7,500 limit.
Benefits of solo 401(k)s
Solo 401(k)s operate on a pre-tax basis, meaning contributions are tax-deductible, and investments grow tax-deferred until withdrawn during retirement. Plus, you can defer a sustainable amount of your income since you are considered both an employer and an employee.
You may also be eligible to take a 401(k) loan if you need funds in an emergency. SEP IRAs do not offer this withdrawal flexibility.
What is a SEP IRA?
SEP IRAs are alternative retirement savings plans for small businesses and self-employed individuals.
Definition and purpose of SEP IRAs
A SEP IRA is a retirement savings plan for self-employed individuals and small business owners with 100 or fewer employees. Employers can make tax-deductible contributions directly to their own accounts and their employees' IRAs with this retirement savings vehicle.
Like a solo 401(k), contributions into a SEP IRA compound over time and earn capital gains from investments.
Eligibility requirements
Eligibility requirements for opening a SEP IRA are simple: You must be at least 21 years old and make a minimum of $650 per year. You must also have worked at your current place of business (or be self-employed) for at least three out of the last five years.
"This three-year period is the longest for any retirement plan," says Matt Bruce, a financial planner and president of Pointer Financial Group. "For a 401(k), the minimum eligibility is one year of service and 1,000 hours over that year. For self-employed individuals who may be hiring or who have new employees they aren't ready to allow in the retirement plan, a SEP IRA allows those employers to exclude those employees for longer."
Contribution limits
SEP IRA contributions are tax-deductible and have tax-deferred growth on the investments. The plan allows for significantly higher contribution limits than a traditional IRA. You can contribute the lesser of 25% of an employee's income or $70,000 in 2025, up from $69,000 in 2024.
For 2024 and 2025, the most you could add to a traditional IRA is $7,000 or $8,000 if you're over 50.
Employers have the flexibility to choose what percent they contribute to their SEP IRAs each year, enabling them to make adjustments based on their business's financial performance. You're also not bound to complete contributions by the end of the tax year. You have up until you file your taxes, which gives you extra time to determine how much to allocate to your SEP IRA plan.
"It's a good tool for those with a few employees that you want to incentivize," says Ryan Derousseau, a financial planner and advisor with United Financial Planning Group. "But you also want to control when you contribute since cash flows in your business may be inconsistent. If you have employees, then you have to contribute to the SEP for them. If it's a down year, you don't. If it's a good year, then you can."
Benefits of SEP IRAs
One key advantage of a SEP IRA is that it is easy to set up and administer, which can be an attractive option for a solo business owner. There are no administrative costs or annual filing requirements. There is also much more flexibility when it comes to contributions over using a solo 401(k) since there are no requirements to make regular contributions.
For employees, SEP IRAs offer the benefit of instant vesting. There are no vesting schedules with SEP IRAs, while it can take up to four years with other IRA accounts.
Key differences between solo 401(k) and SEP IRA
Here are the key differences between solo 401(k)s and SEP IRAs in 2025.
Eligibility requirements
Generally, solo 401(k)s are best suited for self-employed folks with no employees. Solo 401(k)s also offer greater withdrawal flexibility. On the other hand, small business owners with less than a hundred employees may get more out of a SEP IRA due to the plan's easy setup and ease of use.
Loan options
If want the option to borrow against your account in case of emergencies, a solo 401(k) is preferred. Solo 401(k)s allow loans up to 50% of their account balance.
SEP IRAs, on the other hand, don't allow loans. With a SEP IRA, you would have to withdraw early. If you do so, the amount you take out counts as taxable income, and you'll have to pay an additional 10% penalty.
Administrative responsibilities
Those who want simplicity and ease of administration should consider a SEP IRA over a solo 401(k). Solo 401(k)s required significantly more administrative responsibilities, record keeping, and documentation.
"A SEP IRA may be a better option than a 401(k) in certain situations, depending on the needs and circumstances of the individual or small business owner," says Noah Schwab, a financial planner and owner of Stewardship Concepts Financial Services.
Pros and cons of solo 401(k)s vs. SEP IRA
Here are solo 401(k) benefits and drawbacks.
Pros of solo 401(k)s
- Larger contributions are allowed from both employee and employer
- As the employer, you can deduct contributions as a business expense
- You may be able to take loans against the account balance
- Catch-up contributions are allowed
Cons of solo 401(k)s
- Must make regular contributions; no lump sum options
- All contributions must be made before the end of a tax year to the counted for that tax year
- Lengthy paperwork is required to open
- You're disqualified if you hire even one employee
- They can be difficult to change into a SEP IRA
Here are SEP IRA benefits and drawbacks:
Pros of SEP IRA
- SEP IRAs are easy to set up and maintain
- No regular contribution requirements
- You can continue to offer if you add employees to your business
- All funds are immediately 100% vested
- Contributions are tax-deductible
- Contribution limits are higher than traditional IRAs
Cons of SEP IRA
- You can only contribute up to 25% of compensation or adjusted earned income
- Employers must make contributions
- No employee contributions are allowed
- Any funds allocated to the employer SEP IRA must be proportionally added to employee accounts
- You cannot borrow against the balance
- There may be fewer investment options available
How to choose between solo 401(k)s and SEP IRAs
Assessing your business needs
When choosing between a solo 401(k) and a SEP IRA, thoroughly assess your business needs. This includes whether your business meets the eligibility requirements for these plans, the administrative burden, investment choices, tax implications, and benefits.
Considering your retirement goals
Ensure you also consider your retirement goals when choosing between a solo 401(k) and a SEP IRA. Factors like your age, contribution limits, and withdrawal flexibility should be considered when making an informed decision about which retirement plan is best suited for your (and your employees') long-term financial goals.
Not all retirement plans are built equal. So, if you're looking for certain growth-earning features, benefits, or investment opportunities, make sure that the plan you choose meets those needs. For example, if you want access to borrow against your account in case of a financial emergency, a solo 401(k) will be the best choice.
FAQs about solo 401(k) and SEP IRA
What is the main difference between a solo 401(k) and SEP IRA?
The main difference between a solo 401(k) and a SEP IRA is the contribution limits and loan flexibility. Solo 401(k)s allow higher contributions for employees age 50 and older. Solo 401(k)s allow loans while SEP IRAs do not.
Who is eligible for a solo 401(k)?
Those eligible for a solo 401(k) include self-employed individuals and small-business owners with no employees other than a spouse. If you have even one employee, you won't qualify for solo 401(k).
Can I have both a solo 401(k) and a SEP IRA?
Yes, you can have both a solo 401(k) and SEP IRA at the same time. However, there isn't a benefit to contributing to both plans simultaneously unless you have both a small business and self-employed income separate from the business.
Is a SEP IRA or a solo 401(k) better for high-income earners?
A solo 401(k) may be better for high-income earners who are age 50 and older. Younger workers can contribute up to the same amount to both a solo 401(k) and a SEP IRA. However, solo 401(k)s allow older workers to make catch-up contributions, increasing the annual contribution limit.
What are the tax benefits of a solo 401(k) and SEP IRA?
The tax benefit of a solo 401(k) and SEP IRA is tax-deferred growth, offering the benefit of an initial break. You won't pay tax on contributions and growth until you withdraw during retirement at age 59½. This is especially handy if you believe you will be in a lower tax bracket during retirement compared to your working years.
