Solo 401(k) vs SEP IRA: An Easy Comparison

For the self-employed individuals looking for the right retirement plan, there are several choices to review before choosing on. Two of the more popular choices self-employed individuals consider include the Solo 401k and a SEP IRA.

In order to make a more informed decision about which retirement savings plan is best for your current and future situation, you should understand the difference of each plan so you can determine which makes the most sense.

Here is an overview of the differences between a Solo 401k plan and a SEP IRA:

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Solo 401k Plan

The Solo 401k plan is a relatively new concept. This type of plan is a combination of a traditional 401k plan and a profit-sharing plan. It allows self-employed business owners and their spouse to maximize their contributions allowable within a year. The account is funded by the employee and the business. The contribution from the employee is deferred compensation. The business will contribute a part of its profits. A Solo 401k account can include rollovers from other retirement accounts, allowing you to consolidate your retirement funds before it is time for withdrawals.

There are a few criteria that will determine if a Solo 401k account is the right option for you. If you are planning to covert Roth IRA funds, the Solo 401k plan has an advantage because you will not have to include the contributions made in the pro-rata calculation like you would with the SEP IRA plan. You will end up increasing your tax bill on your Roth IRA account conversions.

Another big benefit of the Solo 401k plan is the contribution limits. For 2012, the contribution limits will increase to $17,000. For those aged 50 and older, there is a $5500 catch up allowance in addition to the maximum contribution. You can also contribute 25% of your compensation to a maximum of $49,000.


An SEP IRA is a retirement savings account. The letters SEP stand for Simplified Employee Pension. The plan uses an IRA to hold your contributions towards retirement and is a relatively easy plan to set up. The SEP IRA is considered to be more flexible than a qualified plan and was designed to cater to the future financial needs of small business owners and sole proprietors. There is no vesting period associated with SEP IRA contributions. As soon as an employee has made the contributions, they will have 100% access to those funds. .

An employer/business owner that contributes to an SEP IRA plan within the year must also make contributions for all employees over the age of 21 that have worked for three or more years and have earned at least $550 during the year.

An SEP IRA plan is an ideal choice if you have employees working for you. The Solo 401k does not work for those with employees as it only accommodates the business owner and their spouse.

The SEP IRA is also a good plan if the year is over and you still want to make a contribution for the previous tax year. You have until the tax filing deadline to open and contribute to an SEP IRA and can also include subsequent extensions onto your timeline. With the Solo 401k account, you must have it established by December 31st and cannot fund it until the tax filing deadline.

Reaching a Decision

You may have to go with one type of fund over the other depending on your specific business setup. Both plans are designed to aid self-employed individuals in saving for their retirement years. It is important to first understand the terms and conditions of each type of plan before deciding on the ideal account for you and your business.

If you are a sole proprietor, a partnership, a C Corporation, or an S Corporation, the SEP IRA and the Solo 401k are two retirement savings plan options to consider and you’ll need to determine which best suits your financial needs now and for your long-term financial goals.

Paul Sundin

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