SEP IRA vs. Solo 401(k) – Which is Better for You?

Smart Retirement Options for the Self-Employed.

Alexander Ognenovski, JD

Self-employment has its advantages; yet also comes with responsibility, such as saving for your own retirement. When you work for an employer, you can usually count on there being a 401(k) plan or something similar already in place that you can contribute to. However, when you work for yourself, it’s a different story. Since you are your own boss, you are responsible for both starting your own plan and funding it.


A Simplified Employee Plan (SEP) IRA is a type of Individual Retirement Account that works well for the self-employed or the small business owner. If you have employees, they can also make contributions.  This, however, can be an expensive proposition, since contributions for employees must match the percentage of the salary that the owner makes for themselves.  So, if you have employees, another plan choice (such as a 401(k) or a Simple IRA) may be a better choice.

Some features of the SEP IRA include:

  • Contributions are made entirely by the business. There are no employee contributions.
  • Contributions are a business expense.
  • Contributions can be made up to 25% of compensation. For those who are sole proprietors, this might actually end up as 20% of self-employment income due to the way the calculation flows through Schedule C.
  • The maximum contribution for calendar year 2018 is $55,000.
  • SEP IRA accounts are available through most major custodians.
  • Investment choices are generally the same as for a regular IRA account.
  • A SEP IRA account can be opened and funded up until the date your tax return is filed, including extensions for the prior year.

However, you might want to take note of these limitations:

  • There are no loans available from a SEP IRA.
  • There is no Roth option available.

Solo 401(k

A solo 401(k), also called an “individual 401(k),” is another great solution for the self-employed. The solo 401(k) offers both employee and employer contributions. Most major custodians offer a solo 401(k).  However, the rules may differ a bit from custodian to custodian.

The business owner wears two hats in a 401(k) plan: employee and employer. Contributions can be made to the plan in both capacities. The owner can contribute both:

  • Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
    • $18,500 in 2018, or $24,500 in 2018 if age 50 or over; plus
  • Employer non-elective contributions up to:
    • 25% of compensation as defined by the plan; or
    • for self-employed individuals

A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that their limits on elective deferrals are by person, not by plan. They must consider the limit for all elective deferrals made during a year.

For the Self-Employed, one must make a special computation to figure the maximum amount of elective deferrals and non-elective contributions you can make for yourself. When figuring-out the contribution; compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both:

  • One-half of your self-employment tax, and
  • Contributions for yourself.

Deciding Which Plan Is Best for You.

As with most vehicle options in the world of investing, there is not a one-size-fits-all solution.

There is a more prominent difference that is worth taking into consideration. In years when your income may be lower than usual, the “percentage of compensation” method used for calculating SEP IRA contributions will result in a lower contribution amount for you even if you have the cash to make a larger contribution. In addition, the SEP IRA doesn’t allow for catch-up contributions.

With a solo 401(k), as long as your compensation exceeds the $18,500/$24,500 annual limits, you can contribute the full amount. So if you’re really looking to save for your retirement big-time, a solo 401(k) might be your best bet.

In Conclusion.

When you’re self-employed, it can be easy to overlook investing in a retirement plan. However, there is no reason why you shouldn’t be saving for the future as well.  No matter which plan you choose — whether it’s a solo 401(k) or SEP IRA or another type of retirement savings program — make sure to do your due diligence.  Speak with a trusted JGUA financial expert, and weigh your choices when it comes to choosing a custodian.  I’ll be sure to answer any and all questions you may have, while actively strategizing your retirement plan.