Laura reviews the differences between two popular retirement accounts for business owners, a solo 401(k) and SEP-IRA.
Laura reviews the differences between two popular retirement accounts for business owners, a solo 401(k) and SEP-IRA.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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If you have part- or full-time business income, you can use retirement accounts designed for the self-employed. That's a terrific benefit because they allow you to contribute much more than other accounts, like an individual retirement account (IRA) or workplace 401(k).
This post will review the pros and cons of the two most popular retirement accounts for solopreneurs or small business owners: the solo 401(k) and SEP-IRA. Understanding their differences will help you choose the right plan for your situation and goals.
Welcome back to episode 916 of Money Girl! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, founder of The Money Stack, a Substack newsletter, and host of this podcast with over 43 million downloads.
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What is a solo 401(k)?
A 401(k) is a popular tax-advantaged retirement plan that an employer can offer. And if you're self-employed, you may choose a similar account called a solo 401(k). It's also called a solo-k, uni-k, one-participant 401(k), self-employed 401(k), and individual 401(k)--essentially a plan that covers one employee. However, it can also cover your spouse if you both are the only employees in your business.
You contribute a portion of your paycheck or self-employment income to a solo 401(k) and select investment options, such as mutual funds and exchange-traded funds (ETFs). For 2025, you can save up to $23,500 or $31,000 if you're over 50 in your solo account as an employee, just like with a regular 401(k).
However, since you're also the business owner, you can make an employer contribution to your account, up to 25% of income for a maximum of $70,000 for 2025.
If you're over 50, you can make an additional catch-up contribution of $7,500, for a total of $77,500. Plus, starting in 2025, 401(k)s allow a super catch-up contribution for those aged 60 to 63 up to $11,250, for a grand total of $81,250.
You can set up a traditional solo 401(k), where you make pre-tax contributions. Traditional accounts give you an immediate benefit with tax-deductible contributions, which reduce your annual taxable income and tax liability. You defer paying income tax on contributions and account earnings until you take withdrawals in the future.
You can also establish a Roth solo 401(k), which requires after-tax contributions. However, your future withdrawals of contributions and investment earnings are entirely tax-free.
If you contribute to multiple 401(k)s, such as one through an employer and your own business, the employee limits apply per person, not per plan. That means you can't exceed the following employee limits for 2025, no matter how many 401(k)s you have:
Unlike a Roth IRA, which has an income limit to qualify, there's no income threshold to participate in a Roth 401(k) or Roth solo 401(k). Therefore, even high earners can participate in a workplace or self-employed Roth and reap its terrific tax benefits.
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What is a SEP-IRA?
The other common retirement plan for the self-employed is a SEP-IRA or simplified employee pension IRA. It expands a regular IRA to fit the needs of a business owner, with or without employees. A SEP-IRA allows you to contribute to employees' retirement plans (including your own); however, your employees can't contribute their own funds to the account.
The upside of a SEP-IRA is that contributions don't have to be made through payroll deductions, giving you the flexibility to make them anytime during the year. Or, you can opt not to make any contributions if you don't have a good year.
With a SEP-IRA, you can contribute up to 25% of business income, up to $70,000, for 2025. Unlike a solo 401(k), a SEP-IRA doesn't allow catch-up or super catch-up contributions.
A downside of these accounts is that you must treat everyone equally if you have employees in the plan. For example, if you contribute 5% of your salary to your SEP-IRA, you must contribute 5% of each employee's compensation to their accounts.
The SECURE 2.0 Act allows for Roth contributions to a SEP-IRA. However, I haven't found an investing platform that offers it. So, if you want to make catch-up or Roth contributions, the SEP-IRA may not be for you. Similar to other traditional retirement accounts, contributions are tax-deductible and grow tax-deferred until you take withdrawals in retirement.
Even if you have a 401(k) with an employer, you can max out a SEP-IRA if you're self-employed and have high business income.
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What are the differences between a solo 401(k) and SEP-IRA for withdrawals?
All tax-advantaged retirement accounts have a penalty for withdrawing funds before age 59.5 if they haven't been taxed. Early withdrawals are subject to ordinary income taxes plus an additional 10% penalty.
Since Roth contributions get made on an after-tax basis, you can withdraw them
penalty-free at any time. However, early withdrawals of Roth account earnings would be subject to taxes and a penalty.
However, the "rule of 55" allows penalty-free withdrawals from a regular 401(k) if you leave your job in or after the year you turn 55. Whether that applies to a solo 401(k) is unclear. So, if you're self-employed and planning to retire early, get clarification from a plan administrator about what's allowed.
Traditional accounts have requirement minimum distributions (RMDs) starting at age 73, which increases to 75 beginning in 2033. But there are no RMDs for Roth accounts.
Some regular and solo 401(k)s offer participants loans and hardship withdrawals, while others don't. If your regular or solo 401(k) allows loans, you can borrow up to 50% of your account value up to a lifetime limit of $50,000. You can use the funds for any purpose but must repay yourself for up to five years at a set interest rate specified by the plan.
If you don't repay a regular or solo 401(k) loan on time, it could be considered an early withdrawal, subject to income taxes, plus an additional 10% penalty. However, if you pay it on time, a 401(k) loan is tax-free, regardless of age.
Note that with any IRA-based account, including a SEP-IRA, loans and hardship withdrawals are never allowed.
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While a solo 401(k) has many advantages, including a Roth option, it's only available for solopreneurs or those with a spouse working in their business, and contributions must come from payroll deductions.
A SEP-IRA allows you to hire employees and make contributions that don't have to be deducted from payroll. You can open either type of account at most online brokerages, and get access to a broad range of investment options.
No matter which retirement plan you choose, if you have self-employment income,
investing a portion of it for the future is essential. And, if your situation changes later on, such as deciding to hire employees, you can always open and begin contributing to a different retirement account.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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