SEP IRA vs Solo 401k: Which Fits a Self-Employed Owner?

Written By May Franco

If you are self-employed or own a small business with no employees, the SEP IRA vs Solo 401k decision is one of the most common retirement plan questions you will face. Both plans let owners save on a tax-advantaged basis, often in larger amounts than a traditional or Roth IRA. They work differently, though, and the better fit depends on your income, whether you have employees, your interest in Roth savings, and how the plan connects to the rest of your financial life.

For consultants, physicians with private practices, real estate professionals, and other owners across Wisconsin, this choice touches both sides of planning: how much tax you may defer this year, and how much retirement wealth you may build over time.

Start Here: A Complimentary Wealth and Tax Review

Choosing a retirement plan is easier when you can see your full picture. Compound offers a complimentary, no-obligation wealth and tax review. A review may include:

  • Business income and entity type: how your compensation is calculated for plan purposes

  • Current retirement accounts: existing IRAs, old employer plans, and how they interact

  • Tax projections: how contributions may affect this year and future years

  • Roth considerations: whether pre-tax or Roth savings may fit your situation

  • Investment strategy: how plan assets fit with your other accounts

Request your wealth and tax review.

What Is a SEP IRA?

A SEP IRA (Simplified Employee Pension) is an employer-funded retirement plan. Contributions are made by the business as a percentage of each eligible participant's compensation, and annual limits apply.

Key features of a SEP IRA:

  • Simple setup and administration. There is generally no annual plan filing, and paperwork is light.

  • Employer contributions only. There is no separate employee salary deferral.

  • Flexible funding. The business can decide each year whether to contribute and how much, within the limits.

  • Equal treatment. If you have eligible employees, the business generally must contribute the same percentage of compensation for them as for the owner.

  • Late setup. A SEP can often be established and funded up to the business's tax filing deadline, including extensions.

What Is a Solo 401k?

A Solo 401k (also called an individual or one-participant 401k) is a 401k plan designed for a business owner with no eligible employees other than the owner and, in many cases, a spouse.

Key features of a Solo 401k:

  • Two types of contributions. The owner can contribute as the "employee" through salary deferrals and as the "employer" through profit-sharing contributions. Annual limits apply to each, and additional catch-up contributions may be available for older participants.

  • Roth option. Many Solo 401k plans allow Roth deferrals, giving owners a way to build tax-free retirement savings.

  • Loans. Some plans permit participant loans, which a SEP IRA does not.

  • More administration. Once plan assets exceed a certain level, an annual filing is generally required.

SEP IRA vs Solo 401k: Key Differences

When comparing a Solo 401k vs SEP IRA, several factors often decide the question:

  1. Contribution amount at your income level. Because a Solo 401k allows both employee deferrals and employer contributions, owners with modest or moderate self-employment income may be able to contribute more to a Solo 401k than to a SEP IRA. At higher income levels, the totals may be closer.

  2. Employees. A Solo 401k is generally only available when the business has no eligible employees besides the owner and spouse. If you have or plan to hire employees, a SEP IRA or a traditional 401k may be the more realistic option.

  3. Roth savings. Solo 401k plans commonly offer Roth deferrals. Recent law changes also allow Roth contributions to SEP IRAs in some cases, but availability depends on the provider.

  4. Backdoor Roth IRA planning. SEP IRA balances count toward the pro rata rule for backdoor Roth IRA contributions, which may create unexpected taxes. Solo 401k balances generally do not.

  5. Deadlines and administration. SEP IRAs are simpler. Solo 401k plans have more rules, and establishment and contribution deadlines differ, so timing matters.

For a broader look at pre-tax and Roth choices, read about the convert pretax to Roth strategy.

How Does the Plan Fit Your Tax and Wealth Strategy?

A retirement plan decision is not only about this year's deduction. It is part of a multi-year tax strategy and a long-term investment plan. Questions worth discussing include:

  • Pre-tax or Roth? Deferring taxes today makes sense when you expect a lower tax rate later. Roth savings may make sense in years when income is lower or when you value tax-free withdrawals later.

  • Entity structure. For S corporation owners, plan contributions are generally based on W-2 wages, not total profit, so salary decisions and retirement contributions should be evaluated together.

  • Investment allocation. Plan assets should be invested as part of your overall portfolio, with attention to asset location across taxable, tax-deferred, and tax-free accounts.

  • Business transitions. If you plan to hire, sell, or bring in partners, today's plan may need to change.

To see how consistent contributions may grow over time under different assumptions, try the Compound calculator. Results are hypothetical and for illustration only. You may also find retirement planning in Wisconsin helpful.

Why Tax and Wealth Planning Should Work Together

The right plan depends on numbers from your tax return and goals from your financial plan. When a CPA picks a plan to reduce this year's taxes and a separate advisor manages the investments, the pieces may not line up. Compound brings wealth management, investment management, tax planning and preparation, and client accounting services together, so contributions, compensation, and investments are evaluated as one strategy. See more about wealth management for business owners.

Compound works with self-employed professionals and business owners throughout Wisconsin, including Milwaukee, Madison, Green Bay, Appleton, La Crosse, and Wausau, as well as surrounding areas.

Not sure which plan fits? Request a complimentary wealth and tax review.

Frequently Asked Questions

What is the main difference in SEP IRA vs Solo 401k plans?

A SEP IRA allows only employer contributions, while a Solo 401k allows both employee deferrals and employer contributions. That structure may let some owners contribute more to a Solo 401k at the same income level.

Can I have a Solo 401k if I have employees?

Generally no. A Solo 401k is designed for businesses with no eligible employees other than the owner and, often, a spouse. Businesses with eligible employees typically consider a SEP IRA, SIMPLE IRA, or traditional 401k.

Does a SEP IRA allow Roth contributions?

Recent law changes permit Roth SEP contributions, but not every provider offers them. Solo 401k plans more commonly include a Roth deferral option.

Can I switch from a SEP IRA to a Solo 401k?

Many owners do switch as their situation changes. Timing, contribution rules for the year of the switch, and rollover options are worth reviewing with your tax and financial professionals first.

Which plan is better for a backdoor Roth IRA?

A Solo 401k may be more compatible, because SEP IRA balances count in the pro rata calculation that can make backdoor Roth contributions partly taxable.

Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Calculator results are hypothetical, are not guarantees of future results, and do not reflect any actual investment. Investing involves risk, including possible loss of principal. Diversification does not ensure a profit or protect against loss. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.

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About Compound Wealth

As financial situations become more complex, many individuals seek planning that considers more than one aspect of their financial life. Compound Wealth integrates tax planning, wealth management, accounting, and business transition services to help clients evaluate decisions within the context of their broader financial objectives.

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May Franco
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