Why Choose a Solo 401(k) Over a SEP?

Patrick Cote |

BY: SUSAN POWERS, CFA, CPA, CFP®, CPFA®

Many small business owners think of a SEP (Simplified Employee Pension) IRA when they want to save for retirement.  However, below are five reasons why one should consider a Solo 401(k) instead:

  • Higher Contribution Limits: Solo 401(k) plans allow for catch up contributions, currently an additional $6,500 per year if you're age 50 or older, whereas SEPs do not allow for catch ups.  SEP contributions are further limited to an effective rate of 20% of your business income (25% of net income after the contribution deduction). 
  • Contributions for Spouses: If your spouse is involved in the business, a Solo 401(k) allows your spouse to contribute and make additional catch-up contributions as well.   
  • Ability to Make Roth Contributions: Solo 401(k) plans also offer a Roth option, allowing you to make after-tax contributions. This can be advantageous if you anticipate being in a higher tax bracket in retirement or if you prefer tax diversification.
  • Loan Option: Solo 401(k) plans may allow you to take a loan from your account balance, providing a source of liquidity in emergencies or for other purposes. 
  • No Impact on Roth IRA Backdoor Contributions: If you plan to utilize the backdoor Roth IRA strategy, having a Solo 401(k) might be advantageous. SEP IRA balances can impact the tax consequences of executing a backdoor Roth IRA conversion due to the pro-rata rule, whereas Solo 401(k) balances typically do not.

Carefully consider the costs, investment options, and other features of each plan before making a decision. Please contact us to discuss your specific circumstances and we can help you determine the most suitable retirement plan for your needs.