September 2, 2024

3.5 Minutes

Solo 401k vs SEP IRA: Which is Better for State Employees?

Table of Contents

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Key Takeaways!

Solo 401k a retirement plan that takes care of self-employed individuals and small business owners with limited employees
SEP IRA is a traditional IRA that allows employers to make contributions to their employees' retirement accounts
Solo 401k can provide more flexibility and higher contribution limits than a 401a plan
You can take a loan from your solo 401k account
If you want tax-free growth and withdrawals in retirement, you get this benefit with a solo 401k

Two popular retirement plan options for state employees in 2024 are solo 401k vs Sep Ira. But which one is better? After all, everyone wants to choose the right plan to save their hard-earned dollars. Therefore, if you are a state employee who is trying to choose between these two, read this blog to the end. We will break down the key differences between these two plans to help you make an informed decision. Let’s begin from the very start…

Solo 401k vs Sep Ira – what are these plans exactly?

The first thing you need to know about the solo 401k vs Sep Ira is ‘what are these plans exactly?’ Once you get the idea, we will talk about the key differences between both these plans. Moreover, you will also get an idea of solo 401k vs Sep Ira pros and cons. So, stick till the end. Here we go again…

What is a Solo 401k?

This is a retirement plan that takes care of self-employed individuals and small business owners with limited employees. You might also know it by its other name: Individual 401k. Moreover, you should know that it is similar to the traditional 401k plan. However, you will experience more flexibility and have higher contribution limits in this plan. What’s more, the best thing about solo 401k is that you can contribute as both the employee and the employer. Clearly, this helps you maximize your retirement savings.

What is an SEP IRA?

You can think of it as a traditional IRA that allows employers to make contributions to their employees' retirement accounts. The acronym means Simplified Employee Pension Individual Retirement Account. Because it helps business owners provide retirement benefits to themselves and their employees, self-employed individuals and small business owners often choose this one. Here is a short and precise table comparing SEP IRA vs Solo 401k:

Feature	SEP IRA	Solo 401(k)
Eligibility	Self-employed, freelancers, and small business owners	Self-employed, freelancers, and small business owners with limited employees
Contribution Limits	20% of net self-employment income, up to $57,000 (2023)	20% of net self-employment income, up to $57,000 (2023), plus an additional $6,500 catch-up contribution (if 50 or older)
Employee Deferrals	Not Allowed	Allowed, up to $19,500 (2023), plus an additional $6,500 catch-up contribution (if 50 or older)
Loans	Not Allowed	Allowed, up to 50% of account balance or $50,000, whichever is less
Roth Contributions	Not Allowed	Allowed
Required Minimum Distributions (RMDs)	Required starting at age 72	Required starting at age 72
Required Minimum Distributions (RMDs)	Less complex, fewer reporting requirements	More complex, requires more reporting and administrative tasks
Investment Options	Typically limited to traditional investments (e.g., stocks, bonds, mutual funds)	Broader investment options, including real estate, private companies, and more

Important Note:

This table above provides a general overview of the key differences between solo 401k vs SEP IRA. To help select the best plan, you should always consult with a professional state pension advisor.

Solo 401k vs Sep IRA – Key differences

• Contributions

Undoubtedly, one main difference between Sep vs Solo 401k is the contribution limit of these plans. For instance, the contribution limit for a Solo 401k is $63,500, while the SEP IRA contribution limit is $63,500 or 25% of your compensation, whichever is less. This is true only for 2024. Who knows, with time, these limits might go up or down. Moreover, you should know that with a Solo 401k, you can contribute as both the employee and the employer. Clearly, it also allows you to include your spouse as an employee. This is something that you cannot do in Sep IRA.

"If you have a business and your spouse works for you, you can include your spouse as an employee in your solo 401(k) plan. This can allow your spouse to make elective deferrals to the plan, and you can make employer contributions on their behalf."

• Administration

The winner in solo 401k vs Sep IRA administration is the solo 401k. After all, it is generally more flexible. Thus, it is easier to manage than a SEP IRA. In fact, you should know that you have a variety of investment options when you go with a solo 401k. You can also make changes to your plan as needed. In contrast, SEP IRA is very demanding in terms of paperwork. It requires so many administrative tasks. For example:

Task	Frequency	Description
Plan Adoption	One-time	Adopt a SEP IRA plan document
Annual Contributions	Annually	Make employer contributions by tax filing deadline
5500-EZ Filing	Annually	File Form 5500-EZ with the IRS if plan assets exceed $250,000
Participant Statements	Annually	Provide participants with a statement showing their account balance
Plan Amendments	As needed	Update plan document to reflect changes in law or plan design

Important Note:

This table is with assumption that the Sep IRA is with fewer than 100 participants. For 100+ participants, there are additional administrative tasks required.

• Loans

Between self-employed 401k vs Sep IRA, a Solo 401k may be a better option in terms of access to your retirement funds. That’s right! You can take a loan from your retirement account if it is Solo 401k. However, you should know that when you take a loan from your retirement account, there are tax implications that impact your long-term savings. Clearly, SEP IRA does not have these complications because it does not allow loans from your retirement account. If you are a person who finds it hard to save money with an accessibility option, you can benefit from SEP IRA.

Should state employees with 401a eligibility consider a solo 401k?

Another thing that is always a hot topic is whether state employees should consider solo 401k when they are eligible for a 401a plan. For those who are unaware, 401a is a retirement plan that government agencies offer to the state employees. And if you are eligible for it, you should know that a solo 401k is still better. After all, a Solo 401k can provide more flexibility and higher contribution limits than a 401a plan. What’s more, you can use the solo 401k in conjunction with a 401a plan. This will allow you to maximize your retirement savings.

Feature	401(a)	Solo 401(k)
Eligibility	Employers with 1+ employees	Self-employed, solo business owners
Contributions	Employer-only contributions	Employer and employee contributions
Contribution Limits	25% of compensation	20% of self-employment income + $19,500 (2024)
Loan Provisions	No loan provisions	Allows participant loans
Administrative Complexity	More complex	Less complex

Is it wise to consult with a 401k financial advisor?

Yes! It is always a good choice to consult with a 401k advisor when it comes to solo 401k vs Sep Ira. After all, the right financial advisor can help you determine which plan is best for your individual circumstances. With professional guidance, you can easily understand the investment options and plan administration. Here are a few more reasons to get professional advice:

Plan Design and Setup
Fiduciary Responsibility
Investment Selection and Monitoring
Fee Analysis and Negotiation
Compliance and Regulatory Issues
Employee Education and Engagement
Plan Administration and Recordkeeping
Mergers and Acquisitions
Plan Termination or Conversion
Customized Plan Solutions

Furthermore, you should know that the right professional can also help you between 401a vs 403b. 403b is offered only to certain state employees. Clearly, the right professional can help you go through available options till you settle for the right one – whether solo 401k vs Sep IRA or any other eligibility.

Takeaway till now:

It can be overwhelming for the state employees to choose between solo 401k vs SEP IRA. After all, both of these plans have their own key differences. So, if you are a state employee who wants to make an informed decision, you need to consider all these key differences and understand the benefits of each of these plans. For this, you need professional help from an experienced and knowledgeable retirement financial advisor.

A 2022 survey by the National Association of Plan Advisors found that 44% of solo business owners and self-employed individuals used a Solo 401(k) plan, while 26% used a SEP IRA.

Solo 401k vs Sep Ira, Pros and Cons

Every self-employed individual or small business owner is aware of the importance of saving for retirement. Now that we have discussed the understanding and key differences between solo 401k vs SEP Ira, let’s move towards the next thing: pros and cons. Again, the knowledge of these pros and cons will help you make an informed decision.

Solo 401k Pros:

✓ Higher contribution limits:

As aforementioned, you get higher contribution limits than SEP IRAs in solo 401k. Therefore, if you want to save more money, this is a pro you get with a solo 401k. The contribution limit for a Solo 401k is $63,500, while the SEP IRA contribution limit is $63,500 or 25% of your compensation, whichever is less.

✓ Flexibility

Undoubtedly, you get more flexibility with a solo 401k than SEP IRAs. As aforementioned, it helps you choose from a variety of investment options. Moreover, you can make changes to your plan as needed.

✓ Loans

You can take a loan from your solo 401k account. And although it does not sound like a benefit to some people, it comes in handy. After all, no one can know when a financial need may. If you need financial help, your solo 401k allows you to take the loan.

✓ Roth Contributions

If you want tax-free growth and withdrawals in retirement, you get this benefit with a solo 401k. After all, it allows you to make Roth contributions.

✓ Easy Administration

The best thing about the solo 401k plans is that they are generally easier to administer than SEP IRAs. After all, there is less paperwork and administrative tasks in this option.

Solo 401k Cons:

✓ Complexity

If you have a larger business, Solo 401k plans can be complex and require more administrative tasks – compared to SEP IRAs.

✓ Higher Fees

For smaller businesses, Solo 401k plans often have higher fees than SEP IRAs.

✓ Limited Eligibility

Solo 401k plans are only available to self-employed individuals and small business owners with limited employees. Therefore, the eligibility is very limited.

✓ Required Minimum Distributions (RMDs)

You should know that the Solo 401k plans require RMDs starting at age 72, which can increase your taxable income.

Solo 401k Pros	Solo 401k Cons
High contribution limits	Administrative tasks required
Flexibility in investment options	Limited to self-employed individuals
Loan provisions available	Potential for higher fees
Catch-up contributions allowed	Complexity in plan management

SEP IRA Pros:

✓ Easy to Establish

One big benefit of SEP IRAs is that these are easy to establish and require minimal paperwork. There are administrative tasks, but you can work your way around it.

✓ Low Fees

Compared with solo 401k, the fees of the SEP IRAs are low. Therefore, these are a more cost-effective option for you.

✓ Wide Eligibility

Any employer can choose and benefit from SEP IRAs. After all, these plans have a wide eligibility So, any employer, regardless of size, can go for these. Moreover, you should know that these are a good option for larger businesses.

✓ No RMDs

Clearly, SEP IRAs do not require RMDs. Thus, you get to keep your retirement savings intact.

SEP IRA Cons:

✓ Lower contribution limits

In solo 401k vs Sep IRA, the SEP IRAs have lower contribution limits than Solo 401k plans. Thus, these plans limit your ability to save for retirement.

✓ Limited Investment Options

With SEP IRAs, you only have limited investment options. Therefore, these plans restrict your ability to diversify your portfolio.

✓ No Loans

Because SEP IRAs do not allow loans, these plans are a drawback for those who need access to their retirement funds.

✓ No Roth Contributions

These plans limit your tax-free growth and withdrawals in retirement. After all, these SEP IRAs do not allow Roth contributions.

SEP IRA Pros	SEP IRA Cons
High contribution limits	No catch-up contributions
Easy to establish and administer	No loan provisions
Flexible contribution schedule	Must cover all eligible employees
Low administrative costs	Limited investment options

Ultimate Decision: Solo 401k vs SEP IRA

If you are deciding between solo 401k vs Sep IRA, you need to weigh many factors along with the pros and cons that we have shared with you. For example, you need to consider your individual circumstances and retirement goals. However, you need to know that generally a Solo 401k is the better option due to its higher contribution limits and flexibility. This is for self-employed individuals or small business owners. Therefore, if you own a larger business or want a more cost-effective option, a SEP IRA may be the better choice. But don’t just go ahead with this on your own. Here’s what you should do before you finalize your decision…

Consult a 401k Financial Advisor

Before making a decision, it's a good idea to consult with a 401k financial advisor. After all, the right financial advisor can help you determine which plan is best for you. You do not need to consider your individual circumstances or retirement goals alone – the advisor will do it for you, with you. Moreover, these advisors are better equipped to help you. In fact, these advisors are better equipped to help you than anyone else. Why? Well, these advisors know the state laws, rules, and regulations in terms of retirement plans. So, if you want to be in touch with one such advisor, let State Pension Advisors help you. We connect people with the right advisors – in their state – all the time. You can reach out right away to book a meeting. The advisors we connect you with are vetted as well.

Final thoughts on solo 401k vs SEP IRA

It can be overwhelming to choose between solo 401k vs SEP IRA. After all, both of these plans are unique with their own key differences, pros, and cons. But with a good understanding of these plans, you can make an informed decision. Here’s what you need to do:

Consider your circumstances
Focus on Retirement Goals
Understand the benefits
Pay attention to drawbacks
Get professional help

Without these, you cannot secure your financial future. Because retirement savings are crucial for state employees, choosing the right plan can make all the difference. So, take control of your retirement savings and secure your financial future. Get consultation from a 401k financial advisor and consider your individual circumstances before making a decision.