Over a dozen retirement structures are offered to self-employed business owners. However, those structures often don’t work very well together.
The IRS does not want you to layer one retirement plan on top of another. They will either prohibit plans from being combined or have limitations.
Two of the more popular plans for business owners are 401(k) plans and SEPs. In this post, we will discuss whether you are able to fund both of these plans in the same year.
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Some background
Many clients want to contribute to multiple retirement plans in the same year. If this was possible without restriction, you could fund multiple plans which could allow a substantial contribution. You might not even need a defined benefit plan.
With 401(k)s and SEPs being the most popular plans for business owners, these are the two plans that most people want to combine. But can you make contributions to both plans in the same year?
Both plans are defined contribution plans, and each has its own set of rules. Complicating the issue is that most SEPs are established using IRS Form 5305. This form has even more strict rules and requirements.
What is a SEP retirement plan?
A SEP (Simplified Employee Pension) is a retirement plan for self-employed individuals and small business owners. Employers can contribute up to 25% of employee’s W2 compensation. For a sole proprietor, they can contribute up to 20% of business net income.
SEPs do not allow employee contributions. All contributions come from the employer. In reality, these plans act very much like profit-sharing plans.
A Model-SEP retirement plan is a simplified version of a SEP plan created using IRS Form 5305-SEP. It is designed to make setting up a SEP IRA easier for small businesses and self-employed individuals.
What is a 401(k) retirement plan?
A 401(k) is a retirement plan that has two components: (1) an employee deferral; and (2) a company profit-sharing. Because of the two components, clients can often get larger contributions in compared to a SEP.
The annual employee contribution limit in 2025 is $23,000. Employees age 50 or older can contribute an extra $7,500. Investment earnings grow tax-deferred until withdrawal. Some plans offer Roth 401(k) options for after-tax contributions.
As a general rule, 401(k) plans allow business owners to make larger contributions, and the plans offer a bit more flexibility.
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Can you contribute to a SEP and 401(k) in the same year?
Unfortunately, you cannot fund both a Model SEP (using IRS Form 5305-SEP) and a 401(k) plan in the same year for the same employer. Here’s why.
IRS Form 5305-SEP explicitly prohibits an employer from maintaining another qualified retirement plan (like a 401k) in the same year. If you’re using a Model SEP, you can’t fund any other active qualified retirement plans. This includes a 401(k), profit-sharing, or defined benefit plan.
If you take a look at the instructions to IRS Form 5305-SEP, you will see the following:
If you want to fund both a SEP and a 401(k) in the same year, you must use a custom (non-model) SEP, not the 5305-SEP version. But even using this approach, you would be limited to 6% of W2 compensation. In most situations, clients will have no idea which type of SEP they even have.
Final thoughts
In summary, while both SEP IRAs and 401(k) plans offer valuable retirement benefits, they generally cannot coexist under a Model SEP. IRS rules strictly prohibit maintaining a 401(k) plan alongside a SEP established with Form 5305-SEP.
To use both plans in the same year, a custom or prototype SEP must be adopted. Understanding these distinctions is crucial to avoid compliance issues and ensure your retirement strategy aligns with IRS regulations.
Is a Cash Balance or Defined Benefit Plan Right For You?
