Solo 401(k) vs. SEP-IRA: Key Differences for Self-Employed Investors

In accordance with a QuickBooks survey in collaboration with Gallup, as many as 44 million employees reported being self-employed in some unspecified time in the future throughout any given week in 2019. That quantity has probably jumped considerably with the rising reputation of aspect hustles and with the influence of the COVID-19 pandemic.

With so many People now accountable for their very own work advantages, self-employed employees are left with the choice to choose an applicable retirement plan. This typically means selecting between a Solo 401(ok) vs. a SEP-IRA.

Undecided which retirement plan is best for you? Learn on to find out about the important thing variations between these funding choices.

Solo 401(ok) vs. SEP-IRA: The fundamentals

Solo 401(ok)s and SEP-IRAs can be found to small enterprise house owners, together with freelancers and unbiased contractors. However every plan has distinct benefits and drawbacks when evaluating the 2 funding choices.

Right here’s a fast breakdown of the important thing variations between a SEP-IRA vs. a 401(ok).

Solo 401(ok)


Self-employed necessities

No different workers (besides partner)

With or with out workers

Contribution restrict

  • Employer: As much as 25% of worker’s compensation

  • Worker: $19,500

  • Most complete: $58,000 (excluding catch-up contributions)

  • Employer: As much as 25% of the worker’s compensation

  • Worker: Not allowed

  • Most Whole: $58,000

Catch-up contributions allowed

$6,500 after age 50


Possibility for Roth (after-tax) contributions



Now, let’s take a deeper have a look at a Solo 401(ok) vs. SEP-IRA.

What’s a SEP-IRA?

A SEP-IRA, brief for Simplified Worker Pension Particular person Retirement Account, is accessible to any enterprise with a number of workers.

Though it has the phrase “pension” in its title, it’s not an outlined profit plan. As an alternative, a SEP-IRA features equally to a private IRA (e.g. Conventional or Roth IRA) when it comes to receiving favorable tax advantages, like tax-deductible contributions and tax-free progress.

However in contrast to with a private IRA or a Solo 401(ok), a SEP-IRA is established by the enterprise entity, and solely the employer is permitted to make a contribution.

Though workers aren’t allowed to make their very own elective contributions, self-employed people can make a contribution because the employer to their very own account. That is the case even if you happen to’re a one-person present with out different workers.

This can be a large perk contemplating SEP-IRAs include a excessive contribution restrict.

For 2021, an employer can contribute the lesser of both 25% of the worker’s compensation or $58,000. Relying in your revenue, this might be considerably greater than a private IRA, which has an annual restrict of $6,000 (or $7,000 if you happen to’re at the very least 50 years previous).

Different noteworthy SEP-IRA options embody:

  • The IRS requires you to contribute the identical proportion of compensation to all workers as you contribute to your personal.
  • Employer contributions (together with contributions to your personal account) are totally tax-deductible as much as sure IRS limits, which suggests you’ll obtain a dollar-for-dollar tax break in taxable revenue.
  • Workers are all the time 100% vested in all contributions made to a SEP-IRA.

SEP-IRAs are usually simple to ascertain and function in comparison with conventional employer-sponsored retirement plans. Most main brokerages provide this retirement choice with the flexibility to open it on-line.

What’s a Solo 401(ok)?

A Solo 401(ok) is typically known as a person 401(ok), a one-participant 401(ok) or Solo-k. It has the identical guidelines as a standard 401(ok), but it surely’s designed for self-employed people with no workers. Nevertheless, a partner could be eligible to contribute to a Solo 401(ok) in the event that they work for the enterprise.

Relying in your revenue, a Solo 401(ok) would possibly give you a possibility to make greater annual contributions and reap the benefits of larger tax deductions.

Much like a SEP-IRA, an employer can contribute as much as 25% of the worker’s compensation. Should you don’t pay your self W-2 wages, your most contribution has an adjusted calculation that works out to roughly 20% of your web earnings. Seek the advice of IRS Publication 560 for the precise deduction restrict formulation.

However in contrast to a SEP-IRA, the worker can even choose to make elective deferrals as much as $19,500. Plus, people aged 50 and over could make extra catch-up contributions as much as $6,500 yearly.

Nevertheless, complete contributions to a Solo 401(ok) account can not exceed $58,000 for 2021, excluding catch-up contributions.

For instance, let’s say Peter is self-employed with $100,000 in enterprise web income and is underneath the age of fifty. In accordance with The Constancy Self-Employed 401(ok) Contribution Worksheet, he might make as much as $38,087 in contributions for 2021. This contains contributing $18,587 because the employer and $19,500 as worker contributions.

If Peter had been at the very least 50 years previous, he might make an extra $6,500 catch-up contribution. This may max out his permitted retirement contributions at $44,587.

Different noteworthy Solo 401(ok) options embody:

  • A Solo 401(ok) provides you the selection to make post-tax Roth contributions, an choice that isn’t accessible with a SEP-IRA.
  • In case your partner is employed by your enterprise, you possibly can probably double your general family retirement financial savings since their 401(ok) might be topic to its personal annual limits individually.
  • When you’ve got one other employer that provides a 401(ok) plan, your elective deferrals mixed can’t exceed the annual contribution restrict of $19,500.

A lot of these retirement calculations might be difficult, so it’s greatest to seek the advice of a tax accountant for steerage.

What kind of investor advantages from a SEP-IRA vs. a 401(ok)?

Let’s have a look at a couple of situations which will aid you determine which retirement choice is greatest to your scenario when weighing a Solo 401(ok) vs. a SEP-IRA.

Investor situation 1: You’re a freelancer or unbiased contractor

When you’ve got no intention of increasing your enterprise to incorporate different workers, then it’s as much as you to determine whether or not you wish to put money into a SEP-IRA vs. a 401(ok).

Should you’re a excessive earner, you’ll probably profit extra from a Solo 401(ok) because it permits for a larger contribution and tax deduction profit. Nevertheless, SEP-IRAs are usually simpler to arrange and extra accessible than the method to ascertain a Solo 401(ok).

Investor situation 2: You propose to rent an worker in some unspecified time in the future

Should you plan to have an worker sooner or later (apart from your partner), then it’s most likely higher to go forward and select a SEP-IRA now. When you rent somebody, you’ll not have the choice to make use of a Solo 401(ok). So, you possibly can keep away from the trouble of transitioning to an eligible retirement plan sooner or later by going with a SEP-IRA from the get-go.

Investor situation 3: You wish to max out your retirement financial savings on the highest degree

Solo 401(ok) vs. SEP-IRA choices have related most contribution limits from the employer aspect. However a 401(ok) lets you additionally make a contribution as an worker, and it supplies a catch-up contribution for older adults.

You’ll have the choice to make a lot bigger annual contributions underneath a Solo 401(ok), which might considerably enhance your financial savings price.

Investor situation 4: You like to make after-tax contributions

Should you assume you’ll be in a better tax bracket come retirement — or if you happen to simply favor to make after-tax contributions basically — then it is smart to go along with a Solo Roth 401(ok). You’ll pay revenue tax in your elective contributions as an worker now and obtain tax-free withdrawals in retirement.

Different retirement choices for the self-employed

We coated two well-liked decisions, Solo 401(ok) vs. SEP-IRA. However there are additionally different retirement plan choices to discover.

Normally, you possibly can nonetheless contribute to a Roth or Conventional IRA even you probably have a Solo 401(ok) or SEP-IRA. In reality, anybody with earned revenue (together with W-2 wages) is eligible to put money into their very own private IRA.

If your enterprise has a pretty big staff, you would possibly profit extra from offering a SIMPLE IRA or SIMPLE 401(ok) plan. These retirement choices are meant for companies with lower than 100 workers.

When you’ve nailed down which retirement device is your most well-liked technique, you can begin making good investments by yourself with steerage from Scholar Mortgage Planner’s Six-Determine Debt to Six-Determine Web Price funding course.

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