Either a solo 401(k) or a SEP IRA can be a compelling retirement-savings vehicle for self-employed people and small business owners. But which is the better choice for you? Here’s how they compare, according to retirement-planning specialist Nicholas Bunio, CFP…
If your business has employees—or you expect to hire employees in the near future—then the decision regarding a 401(k) or a SEP IRA probably has been made for you. (SEP stands for Simplified Employee Pension.) Any small-business owner or self-employed person is eligible to contribute to a SEP IRA…but eligibility for a solo 401(k) is largely restricted to business owners who have no employees. Exception: You are eligible for a solo 401(k) if you have one employee—as long as that employee is your spouse.
If you do have employees and you open a SEP IRA, you must make contributions for all eligible employees proportionate to the contributions that you make for yourself. Example: If you contribute 10% of your compensation to your SEP IRA, you also must contribute 10% of each eligible employee’s compensation to his/her account. While it is possible for an employee to opt out of a SEP IRA, this can affect eligibility and contributions to participating employees. Thus, most employers make SEP IRA participation a requirement of employment. Eligible employees include anyone who is age 21 or older…earned $750 or more from your business during the year…and has worked for your business during at least three of the prior five years.
With solo 401(k)s, employer contributions to employee accounts aren’t required, since solo 401(k)s are not available to business owners who have non-spouse employees.
If your goal is to contribute as much as possible, a solo 401(k) often is the better option. With a SEP IRA, the maximum 2025 contribution is capped at 25% of your compensation or $70,000, whichever is lower. A similar 25%-or-$70,000-maximum-contribution rule generally applies to solo 401(k)s as well, but with a few key caveats…
Contributions to a solo 401(k) can be made as an employer and/or as an employee. That creates a potential way around that 25%-of-compensation cap. The solo 401(k) 25% cap applies to employer contributions…but as an employee, you can contribute as much as 100% of your compensation, up to $23,500 in 2025. Note: The $70,000 maximum cited above applies to the aggregate contributions you make as both employee and employer—you can’t contribute $70,000 as an employer and an additional $23,500 as an employee.
There is a way for many solo 401(k) contributors to exceed that $70,000 limit. If you’re age 50 or older, you’re eligible to make additional “catch-up contributions” to a solo 401(k), something that is not allowed with a SEP IRA. These catch-up contributions typically can be as much as $7,500 a year, boosting the 2025 solo 401(k) contribution limit to $77,500…or $31,000 with employee contributions alone. If you’re age 60 to 63, you can make catch-up contributions to a solo 401(k) of as much as $11,250 per year, boosting the total contribution limit to $81,250…or $34,750 with employee contributions alone.
In theory, you can make either traditional or Roth contributions to either a SEP IRA or a solo 401(k)…but in practice, making Roth contributions to either of these can be tricky. Many leading retirement account custodians don’t offer the Roth option with one or both of these small-business retirement plans. The custodians that do offer Roth SEP IRAs or Roth solo 401(k)s often are smaller players that impose relatively steep fees—these forms of Roths are such a niche item that many custodians don’t want to bother with them.
If you need money before you reach retirement age, you can take a loan from your solo 401(k), assuming that the custodian handling your account allows you to do so. Loans are not available with SEP IRAs. Rules for a loan from a solo 401(k) are similar to those that typically apply to loans taken from larger employers’ 401(k)s—the loan amount is likely to be capped at half the amount currently in the account or $50,000, whichever is lower…and the money generally must be repaid within five years—potentially longer, if it is used to purchase a primary residence.
Managing a solo 401(k) is potentially more time-consuming than managing a SEP IRA. Most notably, once the balance of your solo 401(k) reaches $250,000, you’ll need to file Form 5500, Annual Return/Report of Small Employee Benefit Plan each year. This is something that is not required with a SEP IRA. But there’s a simple way around this—before your solo 401(k) reaches that $250,000 mark, roll money out of it and into a traditional or Roth IRA. It’s a bit more complex to manage a solo 401(k) than a SEP IRA even with this workaround, but the remaining solo 401(k) complexities are no big deal for a certified public accountant (CPA)—and if you’re a business owner, you’re probably working with a CPA anyway.
One word of caution with a SEP IRA: Each employee has his/her own separate SEP IRA account. This could allow each employee to open accounts at different custodians, which could lead to confusion. For simplicity’s sake, having accounts opened at one custodian is best.
