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Which One Is Best? SEP IRA vs. Solo 401k

Being self-employed doesn’t mean you’ll fail to benefit from the tax benefits that formal employees get as conventional retirement plans. There are two outstanding alternatives: SEP IRAs and Solo 401(k) plans.

They both have matching advantages, but their few differences are what make one better for you.

What is a SEP IRA?

Simplified Pension Individual Retirement Account (SEP-IRA) applies for self-employed and small business owners and employees. It allows you to contribute to your retirement savings with your employees doing the same.

Your contributions are tax-deductible, and your money grows without being taxed.

How is a SEP IRA Calculated?

You can contribute to a SEP-IRA annually. For 2020, the contribution limit is $57,000, equivalent to 25% of the employees’ compensation for the year.

In 2021, it stands at $58,000. That means the limit on the compensation you can use is $285,000 in 2020 and goes up to $290,000 in 2021.

What is Solo 401k?

A solo 401(k) is a 401(k) plan limited to self-employed individuals. Spouses who work for them at least on a part-time basis may be eligible to contribute as well.

If you run a small business with an employee who is not your spouse, you may not be eligible to save for retirement in a Solo 401(k) plan.

It lets you make the after-tax Roth contributions. You also save more at a lower cost.

How is the Solo 401k Plan Calculated?

If you’re below 50 years, you can contribute a maximum of $57,000 in 2020. If you’re above 50 years, you can contribute a maximum of $63,000.

However, your first $19,500 can be contributed up to 100% of your compensation. After that, the calculation is the same as a SEP IRA. But, it can be stacked.

For example, if you earn $100,000 and under 50 years old, you can contribute $19,500 as an employee of your own company.

In addition, you are able to contribute towards the employer portion, or profit sharing. This is an additional $25,000 (25% of $100,000) with a total of $44,500 for 2020.

Which is the best between a SEP-IRA and Solo 401k?

If you’re self-employed with no employees other than a spouse, Solo 401(k) is the best option since its potential tax saving is higher. It also offers more-on par with other employer-sponsored retirement plans that SEP doesn’t offer.

For instance, you can take out a loan from your Solo 401(k) of $50,000 and below or 50% of your account balance. It offers catch-up contributions if you’re aged 50 and above and the Roth option.

Roth option helps you pay income tax in exchange for withdrawals retirement that is tax-free.

If you need help finding which plan makes sense for your company, schedule a plan discussion with us below.


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