SEP IRA vs. Solo 401(k): What’s the Best Plan for Your Future in 2023?

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Author: Kelly Woo, CFP

SEP IRA and Solo 401(k) are retirement plan options for business owners, independent contractors, and/or freelancers that have earned income from their business. Depending on circumstances, one plan may be a better option than the other.

If you fall into one of the above categories, a couple things to consider when deciding on a plan are whether or not you have employees, or if your goal is to maximize contribution limits within your retirement plan.

SEP IRA and Solo 401(k): Key Differences

For the most part these plans are very similar, but with a few important differences.

Filing

Both SEP IRA and Solo 401(k) are easy to set up and maintain; however, SEP IRA does not require annual filing whereas Solo 401(k) requires annual filing of the Form 5500. Although filing the Form 5500 itself is not difficult, once employees are hired the Solo 401(k) may need to be converted to the traditional 401(k) and this may require more administrative work and additional fees to maintain the plan.

Eligibility

For SEP IRA, whether they are part-time, seasonal, or full-time employees, they are eligible as long as they meet the following requirements:

  • 21 years or older

  • Have worked with the company for 3 years in the last 5 years

  • Earned more than $600 of income that year

If the employee is eligible, the employer would give equal percentage of benefits as they have paid towards their own account, so it may become costly to maintain if one has many eligible employees.

SEP IRA Contribution Limit

With a SEP IRA, there are two options for the maximum contribution amount (within the $66,000 contribution limit for 2023):

  • 25% of W-2 or

  • 20% of Schedule C amount

For example: Lindsay, age 51, owns an S-Corporation with a W-2 totaling $50,000 and net-profit (K1) of $50,000. Her SEP IRA contribution should be less than $12,500, although the net-profit may support higher contributions based on the dollar limit.

Solo 401(k) Contribution Limit

For the Solo 401(k), there are two components that allow contributions of up to $66,000 for year 2023. If you’re over 50, the limit is $73,500:

  • Elective deferrals – 100% of compensation

    • $18,500 for those under 50 years of age

    • $24,500 for those over 50 years of age

  • Non-elective deferrals

    • 25% of compensation by the company

For example, let’s look at Lindsay again. She can elect to defer up to $24,500 from her compensation and have the company contribute $12,500 (which is 25% of her salary), totaling $37,000 in contributions to her Solo 401(k) plan for that year -- unlike SEP IRA, where she is limited to a $12,500 contribution.

In summary, in this situation the Solo 401(k) allows a 3 times larger contribution than SEP IRA at the same level of income for a business owner with a $50,000 W-2.

Money & Mimosas Solo 401(k) vs SEP-IRA

SEP IRA vs. Solo 401(k) Comparison at a Glance

Here are some other factors to keep in mind and a quick chart to illustrate the differences between both retirement plans:

Money & Mimosas Solo 401(k) vs SEP-IRA

The bottom line

Both retirement plan options have solid benefits catered towards business owners. The ease of filing and maintenance make them ideal options. When deciding which option to choose, it is important to note differences and determine which is better suited to your unique situation and circumstances. Please consult with a financial professional or your CPA before deciding on a retirement plan.

For more information, please contact info@ProfectusFinancial.com

Disclosure: Profectus Financial does not provide legal or tax advice. Please consult your own legal or tax adviser for qualification and deciding to go with any investment or tax strategies. This article is for educational purpose only. This is not a solicitation of a particular investment product or company.

Kelly Woo from Profectus Financial

About the author: Kelly is a Co-Founder and Principal of Profectus Financial and Profectus Wealth Management Company. She has been in the financial services industry since 2006 and has been successful at consulting high-net worth business and individual clients with their retirement, investment and tax saving planning. Her expertise is in alternative investments, insurance planning, and advanced pension planning. She specializes in creating a holistic portfolio with diversified asset classes to minimize risk and maximize returns for her clients. Before co-founding Profectus Financial, she was a principal partner at RGL Group Financial. You can learn more about her and her firm at www.profectusfinancial.com.

Disclaimer: the content presented in this article is for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.