Overview
Choosing between a SEP IRA and a Solo 401(k) is one of the most impactful decisions a small-business owner or self-employed professional can make for retirement savings. Both plans let business owners save pre-tax (traditional) retirement dollars, but they differ in contribution structure, employee treatment, plan features (like loans and Roth options), and administrative requirements. This guide compares the two plans, explains how they work in practice, and gives a practical decision framework you can use for your business.
Quick comparison (conceptual)
- SEP IRA: Employer-only contributions, flexible year-to-year funding, simple setup and administration, contributions must be proportional for eligible employees.
- Solo 401(k): Employee deferrals plus employer contributions, potential Roth and loan features, higher recordkeeping and administration if plan assets or employees change.
Why this matters
Retirement plans affect your current taxes, how much you can save each year, and how you’ll manage payroll and benefits if you hire employees. The wrong plan can limit your ability to maximize retirement savings or increase administrative burden unexpectedly.
Eligibility and who each plan suits
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SEP IRA: Any employer (including sole proprietors, partnerships, and corporations) may set up a SEP, and employers make contributions on behalf of eligible employees. A SEP is attractive when you want a low-cost, low-complexity way to offer retirement benefits to employees and owners. Important: employer contributions must generally be made to all eligible employees at the same percentage of compensation.
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Solo 401(k): Designed for business owners with no full-time employees other than a spouse. If you have W-2 employees (other than a working spouse), a Solo 401(k) is usually not permitted. Solo 401(k) plans are ideal when an owner wants to maximize annual savings and take advantage of employee deferrals plus employer contributions, or when you want loan or Roth options.
How contributions work (structure, not specific dollar amounts)
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SEP IRA contributions: All contributions are made by the employer and are typically calculated as a percentage of compensation. For owners, the allowable contribution is based on net self-employment income and follows IRS rules for self-employed compensation calculations (which effectively lowers the percentage compared with the simple employer percentage used for W-2 employees). Employers have discretion each year whether to contribute and how much, but if they contribute, the same percentage must be applied to all eligible employees.
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Solo 401(k) contributions: The owner wears two hats. As the employee, the owner can make elective deferrals (salary-reduction contributions) up to the annual employee deferral limit set by the IRS; as the employer, the owner can also make profit-sharing style contributions up to a percentage of compensation. The combined employee deferral plus employer contribution cannot exceed the IRS’s overall annual limit (which changes annually). Solo 401(k)s typically offer catch-up contributions for participants age 50 and older (as an employee deferral feature), and many plans allow Roth (after-tax) deferrals.
Key differences that affect decision-making
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Employee coverage and fairness: If you have eligible employees, a SEP requires the same contribution percentage for those employees as for yourself. That can be costly if you plan large owner contributions. A Solo 401(k) is only for owner-only operations (plus spouse), so it’s not an option once you hire employees you must cover.
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Contribution flexibility: SEP allows employer flexibility year-to-year (you can skip contributions). Solo 401(k) also allows employer contributions to be discretionary, but employee deferrals must be made by payroll timing rules. If you want a simple plan and expect modest employer-only contributions, SEP can be easier.
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Maximum annual savings potential: Solo 401(k) commonly lets an owner contribute both as an employee and an employer, which often permits higher total annual savings than employer-only SEP contributions — particularly for owners with high discretionary cash flow who can make employee deferrals. Exact dollar limits change annually; always check current IRS guidance (see IRS links below).
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Roth and loans: Solo 401(k) plans frequently offer Roth (after-tax) deferral options and the ability to take loans from the plan (subject to plan rules and IRS limits). SEP IRAs do not permit loan provisions and do not offer a Roth contribution mechanism.
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Administration and reporting: SEP IRAs require minimal administrative work. Solo 401(k)s stay simple until you reach certain thresholds (for example, if plan assets exceed a reporting threshold or you hire employees) that trigger Form 5500 filing requirements and additional compliance tasks. Verify the current filing thresholds on the IRS website.
Tax treatment summary
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SEP contributions are employer-deductible and immediately vest according to the plan’s terms (employers typically set vesting at 100%). For sole proprietors, contributions are deductible on the business return and reduce taxable business income.
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Solo 401(k) employee deferrals reduce your taxable income in the year of contribution if made pre-tax; employer contributions are deductible by the business. Roth employee deferrals (if offered by your Solo 401(k)) are after-tax and grow tax-free for qualified distributions.
Practical examples (hypothetical scenarios)
Scenario A — Freelancer with no employees who wants maximum annual savings:
A solo consultant who wants to aggressively fund retirement and prefers the option to make catch-up contributions after age 50 and use a Roth option would likely favor a Solo 401(k). The plan allows both employee deferrals and employer profit-sharing contributions, which together usually permit larger total annual contributions than an employer-only SEP.
Scenario B — Small owner with several part-time eligible employees who values simplicity:
If you run a small retail shop with part-time eligible employees and want an easy plan that allows employer-only discretionary contributions, a SEP IRA may be preferable because employer contributions must be proportional for eligible employees and setup/admin is straightforward.
Common misconceptions and traps to avoid
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“I can give myself a bigger percentage than my employees under a SEP.” Not true: SEP contributions are employer contributions and must be made pro rata to all eligible employees at the same percentage.
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“Solo 401(k) always lets me save more.” Often true for high earners because of employee deferrals, but only if you are truly employee-free or only employ a spouse. Hiring an employee can invalidate the Solo 401(k) if they are eligible.
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“SEP IRAs have Roth options or loans.” They do not. If Roth flexibility or plan loans matter, a Solo 401(k) is the vehicle to consider.
Administrative checklist before you choose
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Confirm employee status: Do you have eligible employees now or within the next 12 months? If yes, a SEP might be simpler now, or consider a traditional employer 401(k) if you want employee deferrals and matching across staff.
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Estimate your intended annual contribution level: If you expect to make large, recurring contributions and want catch-up/Roth flexibility, Solo 401(k) likely wins.
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Evaluate recordkeeping capacity and budget: Solo 401(k) providers vary in fees and service levels; compare providers and confirm Form 5500 requirements and costs if assets grow.
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Check latest IRS limits and rules: Contribution and reporting limits change annually. See IRS pages for up-to-date rules for SEPs and Solo 401(k)s (links below).
Resources and authoritative sources
- IRS — SEP IRAs (Simplified Employee Pension): https://www.irs.gov/retirement-plans/plan-participant-employee/sep-iras
- IRS — Solo 401(k) (one-participant 401(k) plans): https://www.irs.gov/retirement-plans/plan-participant-employee/solo-401k-plans
Internal resources on FinHelp
- SEP IRA (background and setup): https://finhelp.io/glossary/sep-ira/
- Solo 401(k) (features, loan and distribution rules): https://finhelp.io/glossary/solo-401k/
Decision checklist (quick)
- You have no employees (other than a spouse) and want to maximize annual contributions, loan access, or Roth: favor Solo 401(k).
- You have eligible employees or want the simplest employer-only option with flexible annual contributions: favor SEP IRA.
- You might hire employees soon and want flexibility now: consider starting with a SEP for simplicity, but plan for a transition if you later want Roth/catch-up advantages.
Professional perspective
In my experience working with small-business owners, the biggest driver is cash flow predictability and headcount. Owners with variable income often prefer SEP IRAs for the ability to skip contributions in lean years. Owners who consistently generate strong cash flow and want to maximize tax-advantaged savings usually benefit more from Solo 401(k)s, provided they are eligible. If you’re on the fence, compare provider fees and run a hypothetical with your tax advisor showing projected savings under both structures for the next 1–5 years.
Disclaimer
This article is educational and not personalized financial or tax advice. Rules, forms, and dollar limits for retirement plans change periodically. Consult a qualified tax advisor or ERISA consultant before selecting or implementing a retirement plan for your business. For current IRS guidance, see the SEP and Solo 401(k) pages linked above.
