Which is best: Solo 401(k) vs. SEP IRA (+ how to choose)

Knowing when and how to kickstart your retirement when you’re self-employed isn’t always obvious. But there are two great options for folks without a traditional employer: the solo 401(k) vs. SEP IRA. 

A solo 401(k) is for self-employed individuals with no employees other than a spouse, while a SEP IRA is available to solo entrepreneurs and small business owners with staff. 

Whether you just launched your freelance career or you’re an established small business owner, we can help you figure out which account is right for you. 

We’ve looked at the eligibility rules, tax advantages, and other key details to cover everything you need to know. 

 Let’s chat solo 401(k)s

Solo 401(k)s are individually owned 401(k)s that aren’t tied to a separate employer. So, while most Americans can start a 401(k) at their 9-to-5, freelancers and solo entrepreneurs have to open their own plans to invest. 

Otherwise, it functions similarly to a typical 401(k):

• Individuals contribute up to $23,000 in elective deferrals in 2024. 
• Your business contributes up to 25% of your income
• Total contribution of up to $69,000 in 2024.
• Catch-up contributions kick in at age 50+ — up to $7,500 in 2024.
• Penalty-free withdrawals begin at age 59½. 
• Contributions are tax-deductible (unless you open a Roth account).

This is great because 401(k)s have some of the largest annual contribution limits among tax-advantaged accounts. And the employer contributions based on business profits vs. your individual income provide a nice boost that a typical 401(k) can’t match.

You can also choose between tax-deferred traditional accounts and after-tax Roth options to customize your tax strategy. You can even open both, but your contribution limit remains $23,000 across 401(k)s.

Hello, high contribution limits

We touched on this above, but the self-employed 401(k)’s $23,000 contribution limit blows an IRA’s $7,500 annual limit out of the water. And that’s before we factor in employer contributions, which are even sweeter with a solo 401(k). 

First, you get to make elective deferrals as the plan participant and employee. This maxes out at $23,000, and you get a bonus $7,500 catch-up contribution if you’re age 50 or older (that’s $30,500 total).

If your spouse works in the biz, they can also enroll and make their own individual contributions. If you and your spouse max out 401(k) contributions, you’re at $46,000 (excluding catch-up funds). 

Next, you can make employer contributions from your business funds. Typical 401(k)s limit this based on employed income — often matching 50% of contributions up to 6% of your salary. 

Your solo 401(k) employer contribution limit is based on the business’ performance. As your own employer, you can contribute up to 25% of your business’ income, or $69,000 — whichever is less.

The total annual contribution limit is $69,000 a year including employee and employer contributions, excluding catch-up contributions. 

Realistically, most folks aren’t squirreling away that kind of cash each year. But you’ll be hard-pressed to find another retirement account that allows these huge contributions with all of the tax advantages. 

Are you eligible?

This is the real sticking point. A solo 401(k) is almost definitely your best option if you’re self-employed, but you don’t qualify if you have any employees (excluding your spouse). 

If you plan to turn your side hustle into a full-time gig with staff, you can’t keep your solo 401(k) forever. 

You can enroll now and roll the balance into a new account once the business expands, but it might be best to start with a SEP IRA or another alternative. 

Let’s go — tips to open your account

Opening a 401(k) without an employer isn’t difficult, but there’s more to it than a meeting with HR. 

Once you’ve covered the first step — determining whether you’re eligible to open an account — here’s what’s next: 

• Find a plan provider
• Submit an application
• Determine your account type, contribution, and investments
• Start saving

If you need help identifying your retirement goals and working out a strategy, you can work with a professional advisor and use financial planning tools like Playbook. 

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SEP IRA 101

Simplified Employee Pension Plans (SEP IRAs) are geared towards small business owners rather than solo entrepreneurs. That’s the major difference between a self-employed 401(k) and a SEP IRA. 

You can open a SEP IRA as a business owner whether you have employees or not. However, you must offer an account with the same benefits to everyone employed. This is great if you want to expand your business — especially since there aren’t any startup or operating costs.. 

Unlike solo 401(k)s, SEP IRAs are pretty unique compared to a standard IRA:

• Only the employer can contribute with a limit of up to 25% of an employee’s pay.
• Employees are automatically 100% vested and own the account funds.
• Employers can adjust contributions based on business performance as long as contributions are equal across employees. 
• Early withdrawals before age 59½ are subject to a 10% early withdrawal fee. 
• Employees direct their own investments. 

Employer-only contributions

In 2024, employers can contribute the equivalent of 25% of their employee’s pay up to a maximum of $69,000 to a SEP IRA. However, employees can’t contribute on their own.

This isn’t great for an aggressive saver looking to retire early. In this case, you should explore other tax-advantaged accounts like traditional or Roth IRAs to increase contributions and maintain ownership over your retirement strategy.

Business owners have some flexibility with SEP IRAs. They don’t have to contribute to staff accounts every year, but they do have to contribute the same share of pay to employees whenever they save for themself. 

So, as an owner, if you’ve had a particularly bad year, you don’t have to contribute at all. 

Alternatively, you can share your profits and significantly boost contributions for all employees — including yourself — when you outperform your projections. 

Are you eligible?

Businesses of any size can open a SEP IRA without startup costs. Otherwise, there aren’t really any specific requirements for the plan owner. You just need to choose which financial institution you want to open employee accounts with. 

There are specific eligibility rules for employees to participate in a SEP IRA. The government sets maximum restrictions, but you can loosen the reins for your own employees.

Employees must (unless otherwise directed by the business owner):

• Be 21+ years old
• Have worked in the business for three of the last five years
• Earned at least $750 in 2024

Employers can also choose to exclude employees based on:

• Union membership with pre-agreed upon retirement benefits negotiated by the union and employer.
• Nonresident employees without U.S. compensation from the employer. 

Get going — how to start your account

SEP IRAs are easy to start in four steps:

1. Find a financial institution to hold each SEP IRA and serve as trustee for all accounts.
2. Create a written agreement to provide employee benefits, including participation requirements and an allocation formula.
3. Notify employees of the SEP IRA, requirements, and contribution information. 
4. Set up accounts for each eligible employee. 

The IRS provides specific guidelines, including links to required forms like Form 5305-SEP for your written agreement. 

You can set up your plan at any point, up to your business’ income tax return due date.

How to choose the best account for you 

The solo 401(k) is worth it for a lot of solopreneurs — particularly for its double contributions. 

However, there are still plenty of scenarios where a SEP IRA makes sense. And if you’re a business owner or work for a small business with your own side hustle, you might qualify for both. 

Here are some cases to consider if you’re better suited for a solo 401(k) or SEP.

Save the most with a solo 401(k)

You can contribute to your solo 401(k) twice — once with elective deferrals up to $23,000 and again as the employer with contributions up to 25% of your income, for a max total of $69,000 in 2024.

You also get catch-up contributions once you reach age 50 and the countdown to retirement begins.

Finally, your spouse can also open a solo 401(k) if they work with the business. 

The solo 401 (k) is a no-brainer compared to the SEP IRA’s employer-only contribution limit of $69,000. 

Solo 401(k)s can also grow tax-free

Solo 401(k)s come in two flavors. You can choose pre-tax contributions to a traditional account or after-tax cash towards a Roth account. 

Roth accounts are great because you get taxes out of the way upfront. That means you won’t owe any further taxes, and your earnings grow tax free. 

This is ideal for wealth building while minimizing your taxes. 

Most people can benefit from a Roth account, but they’re particularly powerful if you’re still relatively low on your lifetime earnings spectrum. In this case, you’re aiming to pay a lower tax rate now with the expectation that your annual income will increase over time. 

Future taxes would be charged at a higher rate, plus you’d have to pay taxes on earnings and contributions if you opted for a traditional account. Instead, you pay taxes upfront with a lower rate and get tax-free withdrawals as a reward.  

Opt for SEP IRAs if your business is growing

Business owners with full-time employees can’t open a solo 401(k). So consider starting with a SEP IRA if you’re a solopreneur now but looking to expand. 

This way, your contributions continue as your business grows, and you have a built-in retirement benefit to attract quality employees. Bonus: you save on operating costs compared to a 401(k). 

SEP IRAs keep it simple

SEP IRAs are extremely easy to set up and have relatively low requirements for business owners. There aren’t any startup or operating costs, and several institutions provide SEPs. 

So, if you want to get started ASAP, SEP IRAs are much more widely available with quick startups. 

That doesn’t mean they’re maintenance-free. 

Contributions apply to all employees and are flexible based on business performance. So keep an eye on your contributions and how they stack up to your income to avoid over- or under-contributing, which could disrupt your budget and employee well-being. 

Psst. SEP IRAs can boost total IRA contributions — if your plan permits it

Some SEPs have a rule that permits contributions to a separate IRA via the SEP, which allows employees to bypass the employer-only contribution rule.

It’s a little complicated, but some SEP IRAs permit personal pre-tax contributions, similar to if you were funding a traditional IRA. These are your own elective deferrals in addition to your contributions as an employer. 

It’s also totally dependent on your plan provider. If you’re interested, confirm with your plan representative if this is available to you. 

IRA contributions limits are $7,000 in 2024. So that’s an additional $7,000 ($8,000 with catch-up contributions) invested, in addition to your employer’s SEP IRA contributions. 

Important note: Your pre-tax deductions to a SEP IRA might not be tax deductible because of your SEP participation. We recommend you work with a financial advisor if you go this route. 

The Playbook take: Don’t forfeit your retirement because you’re self-employed

No matter how you make money or who you work for, saving for retirement is an important priority. The sooner you start, the better off you’ll be in retirement. 

Comparing a solo 401(k) vs. a SEP IRA is a great start. Many people will have the ability to make larger contributions to a solo 401(k). But, SEP IRAs are the only option between the two for small businesses with employees. 

Want help organizing your investments and debt to start the road to financial freedom? See how Playbook can help get your finances into shape.