SEP IRA vs. Solo 401(k): Understanding Your Retirement Plan Options
As a small-business owner, selecting the right retirement savings plan is crucial for maximizing tax benefits and long-term growth. Two popular options among single or couple-owned and operated businesses are the SEP IRA and Solo 401(k). While both plans offer tax-deferred growth, they have key differences that can impact your overall retirement strategy.
Key Differences at a Glance:
| Feature | SEP IRA | Solo 401(k) |
|---|---|---|
| Employer Contributions | Yes | Yes |
| Employee Contributions | No | Yes |
| Catch-Up Contributions (50+ years old)* | No | Yes |
| Roth Contributions Allowed | No | Yes |
| Loan Provision | No | Yes |
| Establishment Deadline | Tax return due date (with extensions) | Tax return due date (with extensions) |
| Administrative Requirements ** | Simple | Requires more reporting |
* For 2025, the standard Employee contribution limit is $23,500, with an additional catch-up contribution of $7,500 for those age 50 and older, and $11,250 for those ages 60-63, if the plan allows.
** Plan documents, recordkeeping, and potential annual Form 5500-EZ filings once the plan balance exceeds $250,000, while SEP IRAs have minimal administrative requirements.
What is a SEP IRA?
A Simplified Employee Pension (SEP) IRA allows business owners to make employer-only contributions to their own and their employees’ retirement accounts. It is designed for businesses that want to contribute a percentage of compensation toward retirement savings without complex administrative requirements.
Key Features of a SEP IRA:
- Employer-only contributions up to 25% of compensation (20% for sole proprietors or single-member LLCs) or $70,000 (2025 limit), whichever is lower.
- No employee salary deferrals or catch-up contributions for those over 50.
- Can be set up any time before the business tax return is filed, including extensions.
- No Roth option—only pre-tax contributions.
- No loan provisions; funds must remain invested until withdrawal.
Who Should Consider a SEP IRA?
- Business owners with employees who want a simple, employer-funded retirement plan.
- Sole proprietors or freelancers who prefer a low-maintenance, tax-advantaged savings vehicle.
- Those who do not need Roth options or employee salary deferrals.
What is a Solo 401(k)?
A Solo 401(k), also known as an individual 401(k) or one-participant 401(k), is designed exclusively for self-employed individuals and business owners with no full-time employees (except a spouse). This plan offers both employer and employee contributions, allowing for greater flexibility and higher savings potential.
Key Features of a Solo 401(k):
- Employee salary deferrals up to $23,500 (2025 limit), plus an additional $7,500 catch-up contribution for those over 50.
- Employer contributions up to 25% of compensation, with a combined total contribution limit of $70,000 (or $77,500 with catch-up contributions).
- Roth contributions allowed, enabling tax-free growth.
- Option to take loans against the account (lesser of 50% of balance or $50,000).
- More administrative requirements than a SEP IRA but greater contribution flexibility.
Who Should Consider a Solo 401(k)?
- Self-employed individuals or business owners with no employees (except a spouse).
- Those who want to maximize retirement contributions through both employer and employee contributions.
- Individuals who prefer Roth options for tax-free withdrawals.
- Business owners who may need loan access for short-term liquidity
Which Plan is Right for You?
Choosing between a SEP IRA and a Solo 401(k) depends on your business structure, income, and retirement goals. Here are some key considerations:
• If you have employees, a SEP IRA may be the better choice since Solo 401(k)s are only for owner-only businesses.
• If you want to maximize contributions, a Solo 401(k) offers higher savings potential due to employee deferrals and employer contributions.
• If you prefer simple administration, a SEP IRA has fewer reporting requirements.
• If you want Roth contributions or loan access, a Solo 401(k) may be the better choice.
Final Thoughts
Both the SEP IRA and Solo 401(k) offer excellent tax-advantaged requirement savings options for small business owners. Your choice should align with your business structure, financial goals, and tax planning needs. If you need assistance in selecting the right retirement plan, McFee Financial Group is here to help! Contact us today to discuss the best strategy for your financial future.