Solo 401(K) Vs. SEP-IRA for Small Business Owners

Everyone has to plan their tax returns well to avoid penalties or errors. If you own a small business, you should learn about tax deductions and save more for retirement. But planning your retirement demands a thorough analysis of the best options and how to leverage them. For instance, you must have heard about Solo 401(k) and the SEP-IRA from your fellow workers and wonder how to decide between the two. Here is a quick view of everything about them, including contribution limits, to give you a hint.

What to choose – SEP-IRA or Solo 401(k)?

If you opt for the first one, you can open your account as an employer only, while the latter lets you contribute as both. Regarding contribution limits in 2023, you can add up to USD$ 66,000 to the account. Previously, it was USD $61,000. You can deduct your business expense and don’t have to add yearly money to the account. Conversely, a Solo 401(k) account lets you invest up to USD $66,000 as an employee and employer combined. People age 50 and more can add more. 

While SEP-IRA doesn’t have an option for employees, the other has a contribution limit of USD $22,500 this year. Anyone in their 50s can take advantage of a catch-up contribution. Still, in either case, one should honor the overall employee contribution threshold, which can be at most 100% of an individual’s earned income.

Do you wonder about the eligibility criteria? For SEP-IRA, an employee over age 21 can participate in this type of retirement plan. Their annual compensation must be a minimum of USD $600, and they must have worked in the company for three years. You don’t have to worry about your annual income when subscribing to a Solo 401(k). Spouses, partners, and business owners can contribute to the account.

Points to consider when deciding

SEP-IRA can be expensive because you must pay the same percentage for every employee. Another challenge with SEP-IRA contribution is that you have to pay a certain percentage of your compensation. To be precise, calculate your amount every year based on how much you make in that year. Many people select Solo 401(k) to avoid this situation. It suits someone with lots of cash and uncertain income. If your annual income is under $22,500 and $30,000, you can defer your contribution under this. Plus, this plan can give you a loan. This option will be out of reach with SEP-IRA. You can contribute to any of these accounts after the tax filing date. Still, it’s better to discuss this with your plan provider. If you like individual 401(k), you can open this account by year-end.

One of the incentives for investing in an individual retirement plan is the availability of investment opportunities. You can use your account to buy mutual funds, ETFs, precious metals, stocks, etc. Statutory restrictions may apply. Learn about them from your plan provider. You get this option with SEP-IRA, also. But many other benefits are absent here. Hence, you may have made up your mind. Before doing anything, talk to a credible plan provider to understand your option better.

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