self employed ira vs 401k

Solo 401k vs SEP IRA – what you should choose if are self-employed?

As a self-employed person, you have more control over your retirement plan. One reason is because you get to choose your retirement plan. There are two plans that self-employed people commonly choose between: 

  • The solo 401k retirement plan; and
  • The Simplified Employee Pension (“SEP”) IRA 

In this article, we’ll talk about the features of each plan. At the end, you’ll get a clear idea of which one you should go for.

What is a Solo 401k?

A 401k retirement plan (a.k.a individual 401k) is a retirement plan designed for business owners who don’t have full-time employees. It only covers the business owner and their spouse.

So, as a self-employed person you’d come under this scheme.


To qualify for a solo 401k retirement plan, you must:

  1. Prove that you are earning an income as a self-employed individual.
  2. Not have any full-time employees.

Features of the Solo 401k plan (updated for 2018):

  • The contribution limit is $18,500 from your personal income (what you pay yourself as a salary) plus 25% of the business’ income, and the total is capped at $55,000
  • Your limit is increased by $6,000 more (catch-up contributions) if you’re over 50 years old.
  • Contributions to your Solo 401k plan are tax-deferred (i.e. you pay taxes only when you withdraw money from the account)
  • It’s available for a variety of business structures e.g. sole proprietorship, LLC, C-Corp and S-Corp.
  • You can choose the self-directed solo 401k plan where you decide whether to invest in real estate, stocks, mutual funds and private businesses.
  • It comes with a built-in Roth sub-account with no restrictions on what you can contribute
  • It comes with a loan feature – you can borrow up to $50,000 or 50% of the amount account (whichever is lower) for ANY purpose. Plus, you don’t incur any penalties or taxes when you take a loan. Your interest rate is the prime rate.

What is the SEP IRA?

SEP IRA stands for simplified employee plan (SEP) IRA and it is a retirement plan designed for both business owners and people who are self-employed.


  • You have to be over 21 years of age
  • You must have actively running and operating your business for a full three years in the last five years
  • Your business must have earned at least $600 that year

Features of the SEP IRA plan (updated for 2018):

  • The contribution limit is 20% of the company’s income, up to $55,000.
  • The business makes the contributions.
  • The funds in your SEP IRA are tax-deferred.
  • Early withdrawals before retirement age attract penalties.

Should you choose the Solo 401k or SEP IRA?

By and large, we’d highly recommend going for the Solo 401k because it offers so many more great features than the SEP IRA. Let’s examine some of the benefits of the Solo 401k over the SEP IRA below:

  • It’s easier to max out your Solo 401k contributions vs the SEP IRA.  This is because they allow for a fixed $18,500 Salary Deferred portion, regardless of how much your business makes. For the SEP IRA, your contributions are 20% of your income which means your business needs to earn at least $275,000 in income before you can max out your contributions.
  • The self-directed Solo 401k has a Roth option, but the SEP IRA does not. This means you can make contributions towards your Roth account (meaning your earnings from your investments will be tax-free)
  • You can borrow from the Solo 401k, but not the SEP IRA. This is a great way for you to access your savings. You also pay the prime interest rate, which is the lowest interest rate you can get. For the SEP IRA, your funds are pretty much locked up unless you choose to pay the penalty.
  • The Solo 401k can be more tax efficient. This is because you’re able to decide whether to contribute funds from your personal income or business income. So you can make more contributions from the income that is taxed at the lower rate.
  • With a solo 401(k) plan you don’t have to worry about paying any custodian fees as you would with an IRA plan since a custodian is not used.

Planning for when you become a small business owner

Your choice of retirement plan may be affected if you foresee that you’ll be hiring a team and running a small business in the near future.

A SEP IRA plan is considered a good option for small business owners with less than 5 employees. A Solo 401k only covers you and your spouse. So if you’re looking to have a small team, then consider the SEP IRA. If you expect to expand quickly, then choose a traditional 401k or Simple IRA. 


As we saw from the analysis above, the Solo 401k beats the SEP IRA in terms of flexibility and features. This is especially so for self-employed people earning less than $275,000.

For solopreneurs earning more than $275,000 however, the benefits of the Solo 401k may be diminished. This is because you can likely hit the maximum contribution under the SEP IRA as well. If you don’t expect to borrow from your retirement account, then the loan feature in the Solo 401k also has limited value.

Despite these caveats, the ability to direct money into a built in Roth account makes the Solo 401k the clear choice for self-employed people. So if you’re not on the plan already, you should go and set one up! The cost for setting up either plan is very affordable (about $1,200 for a Solo 401k).

Have any ideas about what makes one plan better than the other? Let us know in the comments!


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