How to Compare Solo 401k vs Sep IRA

We are going to explain the definition of a Solo 401k and SEP IRA and show you How to Compare Solo 401k vs Sep IRA

What is Solo 401(k)

Solo 401(k)s are available to businesses that have only one employee, typically the owner. The IRS does not allow a business owner to contribute to a Solo 401(k) if she has employees, but these accounts can cover spouses.

You can contribute up to $56,000 per year to a Solo 401(k), plus an additional $6,000 in catch-up contributions if you are 50 or older. But within that number, there are some additional limits:

  • You can contribute up to $19,000 or 100% of your compensation, whichever is less when you are paid as an employee. This includes a paycheck you receive from your business or any compensation you receive at a day job while running your business. This is also where the $6,000 catch-up contribution applies. If you have a W-2 job in addition to 1099 or business income, the $19,000 is capped across all plans.
  • You can make a profit-sharing contribution of up to 25% of your profit. If you are an S Corp, profit is based on the salary you take.

The total of those two types of contribution cannot exceed $56,000.

In a traditional Solo 401(k), contributions are made pre-tax and distributions are later taxed as income. But there is also a Roth option, in which contributions are made after tax and distributions arrive tax-free.

Non-discrimination testing is not required for Solo 401(k)s.

What is a Solo 401(k) and why is it better than a SEP-IRA? Compare Solo 401k vs Sep IRA


  • Can be established and funded until your tax-filing deadline, which is April 15th for most people
  • Allows you to contribute 25% of profits, with a 2019 contribution limit of $56,000
  • Does not permit loans
  • Does not allow “catch-up” contributions for those over 50

A Solo (or Individual) 401(k):

  • Must be established by December 31 of the year you want to contribute (funding can come later)
  • Allows you to contribute 25% of profits, with a 2019 contribution limit of $56,000. This includes a $19,000 “salary deferral” contribution
  • Includes an additional $6,000 “catch-up” contribution if you are over 50 for a total of $62,000
  • Loans may be permitted from Solo 401(k)s

Because you can usually make a significantly larger contribution to a Solo 401(k) than to a SEP-IRA at a given income level, the Solo 401(k) is usually a superior choice for self-employed individuals with no employees. Higher contributions mean more tax savings and faster growth of your retirement account. 

THE #1 Advantage of a Solo 401 (K) over SEP-IRA

The relative advantage of a Solo 401(k) over a SEP-IRA is most stark for individuals at lower income levels.

DO NOT MESS UP with your SOLO 401(K)

A solo 401k is still a 401k. There are many rules, which you are still supposed to follow even if the plan only covers yourself and your spouse. There are many ways to mess up. The brokerage firms won’t stop you from messing up. Correcting the mess-up can be very expensive.

If you have a solo 401k, treat it with some respect. Either learn the rules thoroughly or hire someone who knows the rules. Document everything. Remember to file the 5500-EZ when the value of the plan assets at the year end exceeds $250,000. Keep the plan as simple as possible. Don’t borrow from it. Don’t buy real estate in it. The more angles you have on the administration side, the more opportunities there are to trip on some rules. Don’t ruin a good thing.


What is a SEP IRA

SEP IRA stands for Simplified Employee Pension IRA. This is a straightforward retirement account with the same basic elements as most IRAs: Contributions are tax-deductible, and distributions you take from the plan in retirement are picked up as income on your taxes.

There is no Roth version of a SEP IRA, so you cannot choose to contribute post-tax dollars which grow tax-free and come out tax-free in retirement.

SEP IRAs only accept employer contributions; individuals cannot make their own contributions from their paystub or bank account.

And like most retirement plans, they come with limits: You can only contribute 25% of your compensation or $56,000 (2019 limit), whichever is less.

If you are self-employed, you can deduct 25% of your net self-employment income.

If you are your business’s sole employee, contributing to a SEP IRA is pretty straightforward.

But if you choose to hire employees, you will be required to contribute the same percentage to their SEP IRA account as well.

Business owners who have SEP IRAs must contribute to them for all eligible employees — those who have worked for the company in three of the last five years provided they earned more than $600 last year and are over 21.

Tax regulations require small business owners to make equal contributions to all SEP IRA accounts for their employees, including themselves. That means if a business owner contributes 20% of her compensation to this retirement plan, she must contribute 20% of compensation for all eligible employees.

However, the contributions are discretionary meaning she can choose whether or not to fund the SEP IRA each year depending on the business’s performance.

Employees have to set up their own IRAs to receive their employer’s contributions, which means the administrative requirements for business owners are limited. SEP IRAs do not require the same nondiscrimination testing or filing of Form 5500 that qualified plans do.

And employers who offer SEP IRAs have no responsibility for helping their employees invest these contributions.

SEP IRA Pros and Cons

On the pro side, opening a SEP IRA for yourself (and your employees if you have them) is generally an easier process than setting up a solo 401(k).

It’s similar to opening a traditional or Roth IRA, and the level of maintenance required with regard to your annual tax filing is also simpler.

Contributions you make on behalf of employees can be written off as a tax deduction, along with contributions you make to your own SEP IRA.

It’s also important to note that self-employed individuals interested in opening a SEP IRA can do so all the way up to the income tax deadline for that tax year in which they want to make the contribution.

For example, the deadline for establishing a SEP IRA for the 2019 tax year is April 15, 2020.

The biggest drawbacks for self-employed workers with a SEP IRA center on taxation and withdrawals. A SEP IRA must follow traditional IRA tax rules there is no Roth option.

That means if you make withdrawals prior to age 59 1/2, you’ll be subject to the 10% early withdrawal penalty unless an exception applies.

Your options for getting around the penalty are limited because SEP IRA plans don’t allow for loans.

Solo 401(k) Pros and Cons

The main advantages offered by a solo 401(k) include the Roth option and being able to take loans from your account, the way you could with an employer’s 401(k). You could borrow up to 50% of your plan’s value or $50,000, whichever is less. That could be helpful if you need money for a large purchase, such as buying a piece of business equipment. The catch, however, is that if you don’t repay the loan, it becomes a taxable distribution. Not to mention you’ll miss out on compound interest that could have accrued on the money had you left it in your plan.

Cost and setup are other cons to keep in mind. A solo 401(k) is generally more difficult to start since there’s more paperwork involved. You may also pay higher maintenance fees to keep the plan open compared to a SEP IRA.

Self-employed individuals looking to open a solo 401(k) can only open one by the end of the calendar year, December 31. However, they can make contributions for the tax year up until the tax deadline for that tax year.

Which one is better Solo 401k or SEP IRA?

The only time the SEP might be preferable is if you’re investing only in conventional highly liquid assets, like stocks or mutual funds.

But if you’re investing in real estate or anything that could be described as an “alternative” asset, the solo 401k is better.

If you need help to set up your solo 401k or need more information to make a final decision which option will be better for your needs plaese contact us at

Florida 813-964-7100

New York 716-565-1300