Small Business Retirement Options: SEP IRA vs. Solo 401K

If you are a small business owner, freelancer or have other side gigs, there are multiple retirement options to choose from based on your needs and unique situation. Understanding your options and making the right choices will allow you to save for retirement and reduce your tax liability. In this article we are going to summarize two of these options … the SEP and a Solo 401K

Solo 401K

A Solo 401K is a plan designed for those who can put away more than the traditional or Roth IRA limits. You can choose this plan if you and your spouse are the only employees in your business. It is funded on a pre-tax basis and distributions during retirement are taxable. And, as with a corporate 401K, you, as an employer, can also contribute to your solo 401K.
So, the “net/net” is that total contributions (employer and employee combined) to your Solo 401(k) cannot exceed $66,000. Catch-up contributions bump the 2023 to $73,500 for employees who are 50 or older. Total contributions cannot exceed 100% of an employee’s annual compensation.
  •  In 2023, as an employee, you can contribute up to $22,500 to your solo 401K, and an additional $7,500 if you are age 50 or above.
  • As the employer, you can contribute up to 25% of your compensation. The IRS defines the 25% as your net earnings from self-employment minus one half of your self-employment tax and the contributions you made to your plan as an employee. Employer contribution is capped @5% of up to $330,000 of compensation.
  • A Solo 401K plan must formally elect to make an employee deferrals contribution by December 31st, however the actual contribution can be made up until April 15th.
  • In 2023, the maximum contribution for a SEP IRA is 25% of your compensation, or net income in case of the self-employed, or up to 66,000.
  • Unlike a Solo 401K, the SEP doesn’t have the option for post-tax or Roth contributions.
  • Like a regular IRA, you have until April 15th to open a SEP IRA and make contributions for the prior tax year.

SEP IRA

A SEP IRA, is the way to go if you have employees other than yourself and your spouse. A SEP does not have the start-up and operating costs of a conventional retirement plan and provides for a significant source of income at retirement. If you contribute to a SEP IRA for yourself, the IRS requires that you also contribute toward the SEP IRA of every eligible employee and those employer contributions must match the percentage of compensation you contribute toward your own. According to the IRS, eligible employees must be at least 21 years old, have worked for you during three of the last five years, and have earned at least $600 in the past year.
Both types of retirement accounts are as easy to set up as any other investment account. More importantly, both are tax deductible which means the more you contribute the fewer taxes you pay. The biggest advantage of both retirement options is that you can contribute much more every year than if you had a traditional IRA.
Get in touch with us, or your own CPA, if you need assistance in deciding what works best for you. We would love to help you make a good choice!

Be sure to consult with your tax professional to analyze your specific tax situation. At Taxperts, we can assess your small business structure and suggest ways to increase your savings. Check out our website, Facebook page, or LinkedIn page to learn more.

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