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SEP IRA vs. Solo 401K: 2 Simple Retirement Plans for the Self-Employed

September 27, 2016
Image courtesy of Graur Codrin at FreeDigitalPhotos.net

Image courtesy of Graur Codrin at FreeDigitalPhotos.net

When you’re self-employed, you might feel on your own for everything including benefits and saving for retirement.  Knowing all of the options available when you own your own business can be overwhelming.  Here are two options to consider for increasing your nest egg:  SEP IRAs and Solo 401(k)s.

What Is a SEP IRA?

A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) allows employers to make contributions to a retirement account on behalf of themselves and their employees (if applicable), as a part of a profit sharing plan.

Contribution Limits: For 2016, you are allowed to contribute the lesser of:

  1. $53,000, or
  2. 25% of your net self-employment earnings

The calculation for net self-employment earnings can be a little tricky as it includes two additional deductions:

  • One-half of your self-employment tax, and
  • Contributions to your SEP IRA

While this sounds confusing at first, the total contribution boils down to 20% of your net earnings from self-employment before taking into account the SEP deduction.

For example, if you made $150,000 during the year, you would be able to contribute $30,000 ($150,000 X 20%).

Deadline to Open: You can open/establish a SEP IRA by the due date of your business’s tax return. For example, if you are a sole proprietor and file a 2016 tax extension (Form 4868), you have until October 15th, 2017 to open a SEP IRA.

Deadline to Contribute:  Contributions must be made by the due date of your business’s tax return for the year (including extensions).

Advantages:  Less paperwork and administration in setting up an account.


What is a Solo 401(k)?

A Self-Employed 401(k) is a qualified plan that was created specifically for business owners who have no full-time employees other than themselves and their spouse.  This plan allows for self-employed individuals to receive tax benefits identical to a general 401(k) plan without being subject to the complexities of ERISA (Employee Retirement Income Security Act of 1974).

Contribution Limits:  There are two components to a 401(k) contribution.

  1. An employee contribution: $18,000 for 2016
  2. An employer contribution of 20% of net self-employment earnings

For example, if you made $150,000 during the year, you could contribute $48,000 ($18,000 employee contribution plus $30,000 employer contribution ($150,000 * 30%).

The total contribution between the employee and employer contribution is limited to $53,000 ($59,000 for taxpayers over the age of 50).

Deadline to Open: You must open/establish a Solo 401(k) by December 31st of the year you want to claim the tax deduction for contributions. For example, if you want to make 2016 contributions to a Solo 401(k) so they are deductible on your 2016 tax return, the Solo 401(k) needs to be opened by December 31st, 2016. This might make a SEP IRA your only option if you are preparing your 2016 return in September 2017 and have not yet set up a plan.

Deadline to Contribute:  Contributions must be made by the due date of your tax return (including extensions).

Other Limitations:  To qualify for the Solo 401(k), you must not have any full-time employees.  A full-time employee is defined as any worker who is employed for at least 1,000 during a given year.


  • Typically allows for the ability to contribute more each year.
  • The ability to contribute the employee portion of your contributions to a Roth account. ($18,000 for 2016 ($24,000 for taxpayers 50 and older).


Tax & Financial Planning Considerations:

  • Contributions to a retirement plan not only boost your nest egg but also typically reduce your taxable income.
  • While Solo 401(k) often provides for higher contributions (which means a greater tax deduction), we have worked with some business owners where the SEP IRA contribution is sufficient in terms of their retirement savings vs. cash flow goals.
  • Even if SEP IRA contributions are sufficient and the higher Solo 401(k) contributions are not needed, a Solo 401(k) might be a good option if you are looking to make Roth contributions (not deductible when made, but also not taxed when distributed in retirement).

Often times a business owner is getting advice from either a tax preparer or financial planner when deciding what type of account to open. Each will have his/her own take on what type of account is more beneficial. At Krozel Capital, we specialize in analyzing your entire financial picture to integrate both tax and financial planning for business owners, allowing us to provide you a recommendation based on your individual needs. Feel free to contact us today for more information about how we can help you plan ahead and build wealth.