Self-employed? Solo 401(k) vs SEP IRA

What is a Solo 401(k)?

A solo 401(k), also called an individual 401(k), is a retirement plan for just yourself. If you are self-employed or if you and your spouse are the only two employed in the business then this option may suit you.

What is a SEP IRA?

A SEP IRA (simplified employee pension) is a retirement plan that will suit you if you have your own business and have a small number of employees. You can contribute to your retirement savings and do the same for your employees.
Next, I will share five important solo 401(k) and SEP IRA rules and features, how they stack up against each other, and I will announce the winner of the two at the end.

Round #1
Who can participate in Solo 401(k) and SEP IRA?

So let’s say you’re a TikTok influencer. You just hit 1 million followers. Your income from ads and sponsorships are coming in and you want to invest that money wisely. The good news is you can contribute to either a solo 401(k) or SEP IRA. But the very important difference is this:
With a solo 401(k), you can contribute both as an employer AND employee. With a SEP IRA, you can only contribute as the employer. Why should you care?
If you’re the only one in the company, you’re not going to care, since you’re both the employer & employee. But if you have a W2 employee, say you hired a virtual assistant to help you out, you cannot contribute to a solo 401(k). That’s why they call it a solo 401(k). You need to be flying solo. If you have contractors who are 1099 employees, you can still contribute to a solo 401(k).

Here is one important consideration for the SEP IRA: Because you’re contributing as the EMPLOYER, if you contribute 10% of your income to your SEP IRA and you have a W2 employee, then you as the Employer are also required to contribute 10% of your employee’s income into his/her SEP. The contribution has to be equal across the board.

Round 1 Winner: It’s a tie. You can use both if you’re self-employed. There is also a con to both if you have a W2 employee.

Bonus Question: What if you’re a TikTok influencer, and you set up an S Corp. Can you set up a solo 401(k) for S corporations?

Answer: Yes. If you’re a sole proprietor, S Corp, LLC or C Corp, and you don’t have W2 employees, you can contribute to a solo 401(k).

Round #2
Solo 401(k) vs SEP IRA: What are the Contribution Limits?

For both solo 401(k) and SEP IRA, as the Employer, you can contribute up to 25% of your compensation, up to a maximum of $69,000 for the 2024 tax year. Based on my experience, after certain deductions and adjustments, it comes to slightly above 18% of my compensation. Work with a tax accountant to get the exact percentage right.

This is where you get to really take advantage of being a small business owner. For most people working as regular employees, contribution limits are less than half that amount, $23,000 for 2024.

Now, if you have a solo 401(k), you can also contribute as an employee! The employee solo 401(k) contribution limit for 2024 is $23,000 for employees under 50 and $30,500 for employees age 50 or older.

For example, if you’re a realtor and you made $150,000 in 2024, you can contribute approximately 25% of $150,000 as the employer in either a solo 401(k) or SEP IRA. That’s $37,500 that you get to invest and deduct from your taxes. But with a solo 401(k), you can contribute an additional $23,000 as an employee! That’s a total of $60,500!

Round 2 Winner: Solo 401(k) wins because of that additional $23,000 employee contribution allowed.

Round #3
When is the Contribution Deadline for Solo 401(k) and SEP IRA?

The contribution deadline for both solo 401(k) s and SEP IRAs are the same. You can make contributions up until the day taxes are due for the year. For example, if you want to max out your Solo 401(k) and SEP IRA contributions for 2024, you have until April 15, 2025 to do it.

Round 3 Winner: It’s a tie. The Solo 401(k) contribution deadline and SEP IRA contribution deadline are the same.

Round #4
Which is better for taxes: Solo 401(k) or SEP IRA?

Say you’re an interior designer and you contribute to a SEP IRA. You get to deduct those contributions from your tax return. But once you withdraw from your SEP IRA during retirement, you’ll have to pay federal & maybe state taxes on the amount you withdraw.

For a solo 401(k), you can usually choose the tax treatment. If you want to take the tax deduction now, you can contribute to a traditional solo 401(k). If you want to let your money grow tax-free, you can contribute to a Roth solo 401(k). You pay the taxes now, but when you withdraw from a Roth solo 401(k) during retirement, you don’t pay a single dime in taxes.

Round 4 Winner: Solo 401(k) wins again.

Round #5
How easy is it to set it up & maintain a Solo 401(k) or SEP IRA? 

They’re both actually easy to set up. When you open a solo 401(k), the provider will usually create a solo 401(k) plan document for you. There are several solo 401(k) providers you can choose from. If you’re a fan of Vanguard, you can create a Vanguard solo 401(k). You can also create a Fidelity 401(k) or ETrade solo 401(k). One downside with a Vanguard solo 401(k) is it does not allow you to roll over an existing IRA into your Vanguard solo 401(k). For about 2 years, I kept calling Vanguard to ask if they will allow this feature soon. We got tired of waiting and ended up opening another solo 401(k) with Etrade. One downside with a Fidelity solo 401(k) is it does not have a Roth 401(k) option.

If you’re setting up a SEP IRA, it’s pretty straightforward to do so via Vanguard or Fidelity or ETrade.  A lot of people forget this next step though. You will need to complete a Form 5305-SEP. It’s just half a page long. No need to file with the IRS. This form officially creates your SEP IRA plan.

How easy is it to maintain: Solo 401(k) vs SEP IRA? Both are easy. However, with a solo 401(k), once the plan’s assets reach $250,000, you’ll need to file a Form 5500 each year to remain in compliance with IRS rules.

Round 5 Winner: SEP wins, since there’s a bit more paperwork with a 401(k).

Who wins overall – Solo 401(k) vs SEP IRA?

There are two ties. The solo 401(k) got 2 points. The SEP IRA got 1 point. Solo 401(k) wins our match!

Solo 401(k) vs SEP: Which is better for you?

It depends on your situation.  If you can contribute a lot of money to it, maybe solo 401(k). If you like keeping things simple, SEP IRA is easier to open and administer.

Contribute to a Solo 401(k) or SEP IRA in 2024!

Now that you have a retirement plan for your real estate, interior design, or TikTok influencer small business, don’t forget you still can contribute to either a traditional or Roth IRA, in addition to a solo 401(k) or SEP IRA. If you make too much money to contribute to a Roth IRA, but you’re interested in taking advantage of a legal tax loophole to grow your money tax-free, watch our video: How to do a Backdoor Roth IRA – 3 Easy Steps!