I’ve recently written about two options for the self-employed professional to save a significant amount for retirement in a tax advantaged way. The SEP IRA, and the Solo 401(k). In this article I’ll summarize the key differences and advantages of one over the other.
While both of these plans will help you achieve your goal of a successful retirement after self-employment, each plan has its own pros and cons to consider.
For a detailed look into both the SEP IRA and Solo 401k for the self-employed professional see these posts:
SEP IRA: Big Tax Savings For the Self Employed Professional
Solo 401k For the Self Employed Professional
Advantages of the SEP IRA vs. the Solo 401k:
- The SEP IRA is simpler to set up and maintain. The Simplified Employee Pension (SEP) IRA is named so for a reason. It is relatively straightforward to set up and requires less reporting over time than the Solo 401k.
- The Solo 401k will require a form 5500-EZ to be filed when the plan reaches $250,000. If and when you hire an employee, their eligibility will need to be determined and non discrimination tests will need to be applied.
- For these reasons, the SEP IRA may also be less costly to administer than the Solo 401k.
- The SEP IRA takes employer contributions only. By only accepting employer contributions the calculation of how much you can contribute is also more straightforward than the Solo 401k. IRS Publication 550 has a table and formula to determine your total contribution. The maximum should work out to 20% of your net earnings from self-employment up to $69,000 in 2024.
- Roth contributions coming soon to the SEP IRA? Secure Act 2.0 allows Roth contributions to SEP IRAs starting this year. However, more clarification is needed. As of this writing, the major custodians are not offering a Roth SEP IRA option.
Who should use the SEP IRA?
The SEP IRA is good for self-employed professionals who make significant income, do not have employees, and want to reduce taxes on their income in the current year. It is a straightforward plan that is relatively easy to set up and maintain.
Advantages of the Solo 401k vs. the SEP IRA
- The Solo 401k has more opportunities for tax planning (pre-tax, Roth, after-tax, backdoor Roth conversions) than the SEP IRA.
- Unlike the SEP IRA, with a Solo 401k the self-employed professional has the ability to get significant retirement savings into a Roth.
- Higher contribution amounts at lower self employed earnings. Due to the ability to do salary deferrals and after-tax employee contributions in additional to employer contributions it is possible to contribute higher amounts to the Solo 401k than the SEP IRA when your self employed earning are below $345,000 in 2024.
- See my detailed post on the Solo 401k for an in depth look at these contribution options and calculations.
- Easier to keep the plan when you hire employees as the employees make most of the contributions, other than the profit sharing. If you plan to hire an employee in the future it may be easier to maintain the 401k plan.
Who should use the Solo 401k?
The Solo 401k is good for self employed professionals who would like to partake in more complex tax planning, especially the ability to have more dollars in a Roth.
Ultimately the plan you choose will come down to your specific tax, retirement, and investing goals.
