Entrepreneurs should compare retirement savings features of SEP IRA and solo 401(k)

Casey Bear |

Owning a small business requires many sacrifices; saving for retirement shouldn’t be one of them.  Fortunately, entrepreneurs have many options, including two popular choices which provide attractive tax benefits while offering different features and restrictions: the Simplified Employee Pension (SEP) IRA and the solo 401(k) plan.

The SEP IRA is not, as the name suggests, a defined benefit or pension-style plan, but instead offers self-employed small business owners and their employees a simple, tax-advantaged retirement savings account.  Any business with one or more employees is eligible for a SEP IRA and there are typically little to no overhead expenses or reporting requirements. Employees are not permitted to make their own elective contributions, although a solo entrepreneur or self-employed person—who is in effect both employer and employee—may contribute acting as employer. The maximum SEP IRA contribution is the lesser of 25% of adjusted net earnings or $61,000 for 2022, making a SEP IRA a good choice for self-employed freelancers whose net adjusted earnings are no more than $244,000 in 2022.

For businesses with no employees (other than the owner and his/her spouse), a solo 401(k) may offer a higher limit on contributions and more attractive tax savings, especially in cases where the individual’s self-employment income is limited.  In addition, owners can borrow from the solo 401(k) an amount equal to the lesser of $50,000 or 50% of the account balance. Solo 401(k)s also offer catch-up contributions for people 50+ as well as a Roth option, which lets the entrepreneur pay income tax now in exchange for tax-free withdrawals in retirement.

The differences between a SEP IRA and solo 401(k) are nuanced but distinct.  An entrepreneur or small business owner should choose the retirement savings option that best meets his or her financial goals by consulting with a Cranbrook Wealth investment professional.