SEP IRAs vs. Solo 401(k)s for Small Business Owners
by Prof. Robert Bloink and Prof. William H. Byrnes
Choosing the right type of retirement savings plan can be a complicated decision for any employer, but the ramifications are further magnified for the small business employer who is also choosing the plan that will provide for their own retirement security. To complicate matters further, many small business owners spend much of their working years focusing on growing a business—often, at the expense of fully funding retirement accounts during the early years. Traditional IRAs are rarely sufficient to allow the business owner to “catch up” when it comes to retirement savings. Fortunately, small business owners have options. Making the “right” choice when selecting a retirement savings plan will depend on the business owner’s unique situation—and it’s important to understand the differences between two of the most powerful types of retirement savings plans: the SEP IRA and the solo 401(k) plan.
SEP IRAs vs Solo 401(k)s: The Basics
Small business owners who establish solo 401(k)s can contribute to those accounts as both employer and employee. Only business owners, partners and their spouses are permitted to participate in the plan. In 2025, participants can contribute up to $70,000 when both the employer and employee-side contributions are considered. On the employee side, the owner can also make use of catch-up contributions if they are at least 50 years old (the limits for 2025 are $7,500, or $11,250 for taxpayers who are 60, 61, 62 or 63).
SEP IRAs can be established by any business, but only allow employer-side contributions. The maximum contribution limit for 2025 is the greater of (1) $70,000 or (2) 25% of compensation (up to $350,000 in compensation may be considered for purposes of calculating the maximum). SEP IRAs do not permit catch-up contributions.
Both accounts are funded with pre-tax dollars. With each type of account, distributions are taxed as ordinary income (and an early withdrawal penalty will apply to distributions taken before age 59 ½ unless an exception applies). Both types of account are subject to the required minimum distribution rules.
Under prior law, a Roth option was only available with the 401(k) model. Post SECURE 2.0, SEPs may be set up as Roth accounts and funded with after-tax dollars.
Choosing Between the Two Options
The ability to max out annual plan contributions is often a significant factor when choosing between a SEP IRA and a solo 401(k). While it may, on the surface, seem that both accounts allow for a total annual contribution of $70,000 in 2025, with SEP IRAs, this is only the case if the account owner earns roughly $280,000 per year. That’s because SEP-IRAs (and the employer portion of a solo 401(k) contribution) are limited to 25% of the client’s compensation.
As a simplified example, clients who earn $100,000 in compensation for the year are limited to a $25,000 SEP IRA contribution. With a solo 401(k), they are entitled to both the $23,500 employee-side solo 401(k) contribution and an employer-side contribution equal to 25% of wages.
Participant loans from SEP IRAs are also impermissible, while a 401(k) plan document can be written to permit participant loans up to certain limits. 401(k)s can also be structured to permit hardship distributions.
Historically, SEP IRAs have been attractive because they’re so simple to establish. The IRS has created prototype documents that can be used to form a SEP IRA, although individually designed plans are permitted. A primary advantage to these plans is that there is no filing requirement for the employer beyond using the Form 5305-SEP to create the plan.
Annual Forms 5500 must be filed by a solo 401(k) with more than $250,000 in assets. That said, business owners should consider that plan providers offer Form 5500 preparation services and can assist with any compliance issues.
One SEP IRA issue to consider is that when an employer contributes on behalf of any employee, they must contribute on behalf of all eligible employees at the same rate (generally expressed as a percentage of compensation). For that reason, SEP IRAs are typically more attractive for business owners with no employees or few employees. Employers with SEP IRAs are not required to fund the account every year, but when they do, they must contribute on behalf of all eligible employees (employees who are at least 21, have worked for the employer for three of the past five years and earned at least $750 per year).
Conclusion
Choosing between a SEP IRA and solo 401(k) requires a careful analysis of the business owner’s individual situation and goals—because the two types of accounts are similar, but not identical. Fortunately, it’s relatively easy to convert to a different type of account if circumstances do change in the future.