All solo business owners should be thinking about retirement account options for their business. It can make a difference in deferring or deducting thousands of dollars each year.
In this article, I’ll discuss SEP IRAs and solo 401(k)s. I think solo 401(k)s are one of the most powerful accounts available. In this article, I’ll explain why.
Most solo business owners have a SEP IRA because this is commonly recommended after filing their taxes. SEP IRAs provide a tax deduction for money contributed to the SEP.
Here’s a summary of how a SEP IRA works:
- Only employer contributions are allowed to be made, no “employee” contributions.
- The maximum that is allowed to go into a SEP each year is $70,000 based on current numbers. But this is based on the following calculations below.
- If you are an S corporation, you can contribute 25% of your compensation into the SEP. So, for example, if you make $100K, you can contribute $25,000 to the SEP. *See note at bottom regarding compensation definition.
- If you are a partnership, sole proprietor, or other, you are limited to 20% of your net income.
- If you have employees, then you need to contribute the same dollar amount for every one of them. For example, if you choose to put in 25% of your compensation, then you need to do the same for all other employees.
- Roth contributions are now allowed to be made in the SEP.
- SEP IRAs trigger the pro rata rule. What I mean by this: If you are over the income limit to make Roth IRA contributions, you cannot fund a Roth IRA if you have a SEP IRA.
Here’s a summary of how a solo 401(k) works:
- This is a 401(k) for a business with one owner and no W2 employees. But you can have the spouse on the same plan as well.
- The maximum that is allowed to go into a solo 401(k) each year is $70,000 based on current numbers in 2025.
- Solo 401(k)s allow you to contribute as both the employer AND employee (unlike the SEP).
- You are allowed to contribute the 401(k)-deferral maximum as an employee as well. This is the major difference/benefit. For 2025, this is an extra $23,500 and a catch up of $7,500 if you are age 50+.
- Roth contributions are allowed to be made in the solo 401(k).
- This account allows for you to make a Roth IRA conversion, also known as a Backdoor Roth IRA contribution, if you are over the income limits to contribute to a Roth IRA. FYI: If your income is too high to contribute to a Roth IRA, you can still get assets into a Roth IRA by utilizing a Roth IRA conversion strategy.
In conclusion, I like the solo 401(k) more for two major reasons:
- It provides both employee and employer contributions allowing you to contribute a lot more for the same income. This can lead to significant tax deductions and savings.
- It allows for a Roth IRA conversion contribution (Backdoor Roth IRA contribution) if you are over the income limits to contribute to a Roth IRA. This can result in significant tax-free dollars just because of the use of a solo 401(k).
*Note on self-employment compensation: If you are self-employed, your allowable contributions are based on compensation:
- Compensation is defined as “earned income”.
- Earned income is defined as net earnings from self-employment after deducting one-half of your self-employment tax AND contributions made for yourself.
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