The solo 401(k) is a simplified way for small-business owners to save for retirement and enjoy some of the benefits of an employer-sponsored 401(k). Its origins date to the Self-Employed Individuals Tax Retirement Act of 1962, but it was popularized by the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. The SEP IRA was established in 1978 as another way for small-business owners to establish retirement accounts for their companies.
A self-employed business can have both of these tax-deferred plansat the same time.With a SEP IRA, individuals can contribute up to 25% of their income to the account. With a solo 401(k), individuals can save up to 100% of their compensation as an employee contribution (though the amount is limited by an annual dollar threshold), while also accepting employer contributions of up to 25% of their compensation .
Key Takeaways
- SEP IRAs and solo 401(k)s both allow small business owners to establish retirement accounts for their employees.
- SEP IRAs are funded by employer contributions alone.
- Solo 401(k)s allow both employer and employee contributions.
SEP IRA vs. Solo 401(k)
SEP IRA
The SEP IRA is probably the simplest way for business owners to help their employees save for retirement. The plan is purely profit-sharing in nature, meaning only the employer can make contributions, and allows owners to make contributions for themselves as well. (Part-time workers, those under age 21, and those who have not worked for the employer in at least three of the previous five years may be excluded.) A SEP IRA can be established anytime before “the due date (including extensions) of your business income tax return for the year you want to establish the plan.”
The annual amount an owner can contribute to their own SEP IRA is the lesser of up to 25% of business revenue—20% in the case of a sole proprietorship or a single-member limited liability corporation (LLC)—or a set dollar amount adjusted for inflation every year ($69,000 for 2024.) The annual contribution limit to an employee’s SEP IRA is the lesser of the dollar limit or 25% of the employee’s total compensation.
One of the main advantages of a SEP is its relative simplicity compared with the rigorous reporting requirements that come with qualified retirement plans, even those that are designed for self-employed persons, such as Keogh plans.
Solo 401(k)
A solo 401(k) is designed exclusively for sole proprietorships that have only one employee (the owner). Also known as an “individual 401(k),” a “one-participant 401(k),” or a “uni-k,” it can also be established retroactively, “provided it’s adopted by the due date, including extensions, for filing the employer’s tax return for the taxable year of adoption, and the employer elects to treat the plan as having been adopted as of the last day of that prior taxable year.”
A solo 401(k) is generally considered a better option for solo practitioners than a SEP IRA, because it offers the following additional features:
- Employee deferrals – Unlike a SEP IRA, a solo 401(k) allows both employer and employee contributions. This allows the proprietor to contribute up to $23,000 to their own plan (in 2024) even if the business loses money.
- Catch-up contributions – A solo 401(k) allows the same annual amount to be contributed by the owner as a SEP does ($69,000 in 2024), but it also allows participants who are age 50 and above to contribute an additional $7,500 as a catch-up contribution.
- Roth contributions – A solo 401(k) allows for post-tax Roth contributions, which can let the owner accumulate a substantial pool of tax-free money over time. A SEP IRA only allows traditional pretax contributions.
- Loan provision – A solo 401(k) can allow participants to take out a loan equal to the lesser of 50% of the plan balance or $50,000. Loans are not available from a SEP IRA.
| Solo 401(k) vs. SEP IRA: Key Differences | |||||||
|---|---|---|---|---|---|---|---|
| Account Type | Employer Contribution | Employee Contribution | Catch-Up Contributions | Roth Contributions | Loan Provision | Establishment Requirement | Operational Requirements |
| SEP IRA | Yes | No | No | No | No | Anytime before filing tax return | Relatively simple |
| Solo 401(k) | Yes | Yes | Yes | Yes | Yes | Anytime before filing tax return | Rigorous reporting requirements |
Which Should I Choose?
Which you choose depends on the circ*mstance of your business. Those who have full-time employees can save for retirement using a SEP IRA, while solo practitioners can opt for a solo 401(k) that has higher contribution limits and other advantages. Note that it is possible not to choose at all: Both plans can be held simultaneously.
How Much Can You Contribute to a SEP IRA?
The contribution limit for a SEP IRA is the lesser of up to 25% of business revenue—20% in the case of a sole proprietorship or a single-member limited liability corporation (LLC)—or a set dollar amount adjusted for inflation. The dollar amount is $69,000 for 2024.
How Much Can You Contribute to a Solo 401(k)?
The total amount you can contribute to a solo 401(k) is $69,000 in 2024. If you are 50 or older, you can make an additional $7,500 catch-up contribution.
What Are the Downsides of a SEP IRA?
The main shortcoming of a SEP IRA is that only an employer can contribute to it. Employee and catch-up contributions are not allowed. Additionally, you can’t take a loan against a SEP IRA, and you can’t have a Roth version.
The Bottom Line
A SEP IRA and a solo 401(k) are each good retirement plans for business owners. Depending on the type of business you have and your retirement goals, one may be a better option than the other. The Internal Revenue Service (IRS) has various publications you can read to determine which will be the best for you and your business. You may also want to seek guidance from a financial advisor.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
Internal Revenue Service. "One-Participant 401(k) Plans."
Internal Revenue Service. "401(k) Plans for Self-Employed Individuals: Fact? Or Fiction?"
Fordham Law Review. "Self-Employed Individuals Tax Retirement Act of 1962."
Internal Revenue Service. "Simplified Employee Pension Plan (SEP)."
Internal Revenue Service. "Employee Plans CPE Topics For 2002: Chapter 15-Simplified Employee Pensions (SEPs)." Page 3 of PDF.
Internal Revenue Service. "SEP Plan FAQs."
See AlsoSelf-Directed 401k LLCInternal Revenue Service. "2024 Limitations Adjusted as Provided in Section 415(d), etc," Page 1.
Internal Revenue Service. "Issue Snapshot — Deductibility of Employer Contributions to a 401(k) Plan Made After the End of the Tax Year."
Internal Revenue Service. “401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000."
Charles Schwab. "Individual 401(k) Plan —Traditional & Roth."
Internal Revenue Service. "Retirement Topics - Plan Loans."
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