What Is A SEP IRA and Solo or Individual 401k?

Posted on January 25, 2022

When we are working with businesses with no employees, outside of the owner(s), we usually land on two main options:

  • Solo 401k (AKA Individual 401k)

Again, if you are looking to put away $6,000 or less per year towards retirement one of these plans would likely not be necessary and instead you could do a traditional IRA.

What Is a SEP IRA and What Do I Need To Know About SEP IRAs?

A SEP standards for Simplified Employee Pension.

  • Contributions and Matching
    • Able to contribute up to 25% of your salary (S Corp) or 20% of net income (Sole Prop or Single Member LLC) with a max of $58,000 (2021).
    • All contributions are pre-tax.
    • This in an employER only contribution, the employee does not personally contribute.
    • Employer MUST contribute the same percentage to all eligible employees.
    • You do not need to contribute every year.
    • Employer contributions can be made up to the due date (including extensions) for filing your tax return.
  • Tax Advantages
    • Business contributions are deductible business expenses.
    • Investment gains are tax deferred until distribution.
    • Roth option NOT available.
  • Filing and Compliance
    • Employer does not need to file a 5500.
    • Discrimination testing is not required.
  • Notes
    • If you are organized as an S Corp you often are trying to take as low of a reasonable salary as possible which can limit the amount of SEP IRA contributions since it is based on a max of 25% of your salary.

What Is a Solo 401k and What Do I Need To Know About Solo 401ks?

These can also be known as Individual 401ks.

  • Contributions and Matching
    • EmployEE contributions up to $19,500 (2021)
      • Catch-Up contributions up to $6,500 (Age 50+)
    • Additionally employER can contribute up to 25% of compensation.
    • Total Max Contributions (EE + ER): $58,000 (2021) – Not included Catch-Up
  • Tax Advantages
    • Business contributions are deductible business expenses.
    • Investment gains are tax deferred until distribution.
    • Offers both pre-tax & Roth options.
  • Filing and Compliance
    • May require annual 5500 filing.
    • Discrimination testing is not required due to having no employees.

Should I Do a SEP IRA or Solo 401k For My Business?

There is no right answer for every business but we are going to outline some general observations to consider.

  • Typically a Solo 401k will allow you to put more money towards retirement, especially with an S Corp owner looking to take the lowest reasonable salary possible.
    • Example: S Corp Owner with a salary of $80,000
      • SEP IRA: Max employER contribution is $20,000 (25% of $80k)
      • Solo 401k: Of your $80k salary, you could contribute as an employEE up to $19,500 and then the employER could match 25% for a total of $39,500 ($19,5000 + 25% of $80k)
    • For this reason we typically steer clients that want to max out retirement as much as possible towards a Solo 401k.
  • Contributions After 12/31
    • You can setup and fund a SEP IRA after the year has been completed.
    • You can fund the employER portion of a Solo 401k after the year is over but the employEE portion would need to be funded prior to year-end.
    • For this reason if the year is already over and you still want to reduce taxable income through a retirement contribution we will recommend going with a SEP IRA. You can then always go with a Solo 401k in the next year assuming you can get on top of it and get it setup and funded early on.
  • Both plans are fairly reasonable and have little compliance required. Note a Solo 401k may have additional compliance as your retirement account grows past a certain dollar amount but still not a huge burden.
  • General Rule of Thumb:
    • S Corp Looking to Max Retirement: Solo 401k
    • After Year-End, Looking to Contribute and Save Taxes: SEP IRA

If you are looking for professional advice and help in this area, we work directly with Life, Inc Retirement Services. Email us for an introduction or visit this page. 

On the link above you can setup a call to connect with an expert and get started right away. There is also a retirement plan evaluator which will guide you towards the best plan for your business.

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