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Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

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One of the best tax deductions for a small business owner is funding a retirement plan. Beyond any tax deduction you are saving for your own retirement.  As a fellow small businessperson, I know how hard you work.  You deserve a comfortable retirement. If you don’t plan for your own retirement who will? Two popular small business retirement plans are the SEP-IRA and Solo 401(k).

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

SEP-IRA vs. Solo 401(k)

SEP-IRA Solo 401(k)
Who can contribute? Employer contributions only. Employer contributions and employee deferrals.
Employer contribution limits The maximum for 2022 is $61,000, this has been increased to $66,000 for 2023. Contributions are deductible as a business expense and are not required every year. For 2022, the employer and employee combined contribution limit is a maximum of $61,000 and $67,500 for those who are 50 or over, respectively. These have been increased to $66,000 and $73,500 for 2023. Employer profit sharing contributions are limited to a maximum of 25% of the employee’s compensation. They are deductible as a business expense and are not required every year.
Employee contribution limits A SEP-IRA only allows employer contributions. Employees can contribute to an IRA (Traditional or Roth, based upon their individual circumstances). Employee contribution limits are $20,500 for 2022 and $22,500 for 2023. An additional $6,500 catch-up contribution is available for participants 50 and over for 2022, this increases to $7,500 for 2023. In no case can this exceed 100% of their compensation.
Eligibility Typically, employees must be allowed to participate if they are over age 21, earn at least $600 annually, and have worked for the same employer in at least three of the past five years. No age or income restrictions. Business owners, partners and spouses working in the business are generally eligible to contribute. Common-law employees are not eligible.

Note the Solo 401(k) is also referred to as an Individual 401(k).

  • While a SEP-IRA can be used with employees in reality this can become an expensive proposition as you will need to contribute the same percentage for your employees as you defer for yourself. I generally consider this a plan for the self-employed.
  • Both plans allow for contributions up your tax filing date, including extensions for the prior tax year. Consult with your tax professional to determine when your employee contributions must be made. The Solo 401(k) plan must be established by the end of the calendar year.
  • The SEP-IRA contribution is calculated as a percentage of compensation. If your compensation is variable the amount that you can contribute year-to year will vary as well. Even if you have the cash to do so, your contribution will be limited by your income for a given year.
  • By contrast you can defer the lesser of $20,500 ($27,000 if 50 or over) or 100% of your compensation for 2022 and $22,500 and $30,000 for 2023 into a Solo 401(k) plus the profit sharing contribution. This might be the better alternative for those with plenty of cash and a variable income.
  • Loans are possible from Solo 401(k)s, but not with SEP-IRAs.
  • Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP-IRA.
  • Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the level of annual government paperwork increases a bit.
  • Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
  • Investment options for both plans generally run the full gamut of typical investment options available at your custodian such as mutual funds, individual stocks, ETFs, bonds, closed-end funds, etc. There are some statutory restrictions so check with your custodian.
  • For those wishing to invest in alternative assets inside of their SEP or solo 401(k), a number of self-directed retirement plan custodians offer this option.

Both plans can offer a great way for you to save for retirement and to realize some tax savings in the process. Whether you go this route or with some other option I urge to start saving for your retirement today 

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

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