SEP IRA vs. Solo 401(k): Which Is Better?

When you’re self-employed, you’re in charge of choosing and funding your retirement plan. In place of an employer-provided retirement plan like a 401(k), you may consider making contributions to a SEP IRA or solo 401(k) plan. But which one is the better option when it comes to saving money for your retirement? Here are the ins and outs of both SEP IRAs and solo 401(k)s, as well as the pros and cons of each. In the end, you’ll need to pick the right plan for your retirement strategy.

A financial advisor can help you create a retirement plan for your goals.

What Is a SEP IRA?

A SEP IRA or Simplified Employee Pension is a type of individual retirement account that’s designed for small business owners and the self-employed. These plans can be set up by a small business for itself and its employees if there are any. With this type of plan, only the employer makes contributions; employees don’t add any of their own money. However, employees are always 100% vested in their accounts at all times.

You can make contributions to a SEP IRA as a self-employed person no matter the size of your business or your business structure. That means you can use one of these accounts for retirement savings whether you have a sole proprietorship, limited liability company or corporation.

For 2025, the maximum amount employers can contribute to a SEP IRA is the lesser of 25% of the employee’s compensation or $70,000 ($69,000 in 2024). There are no catch-up contributions associated with a SEP IRA. Contribution limits for self-employed individuals work a little differently. Contributions are limited to 25% of your net earnings from self-employment, up to the annual limit.

In terms of how SEP IRAs are taxed, they follow the same rules as traditional IRAs. Contributions are tax-deductible, and for self-employed individuals, the IRS has a special formula that determines what amount you can deduct, based on your self-employment earnings.

Qualified withdrawals are taxed at your ordinary income tax rate in retirement. At age 70.5, you must begin taking required minimum distributions, based on your account balance and life expectancy.

What Is a Solo 401(k)?

A solo or individual 401(k) plan is a 401(k) retirement account that’s designed for sole proprietors and small business owners whose only employee is their spouse. With this type of 401(k), the account owner can make contributions both as the employer and employee.

For 2025, the amount you can contribute as an elective salary deferral is 100% of compensation up to the annual limit of $23,500. That number stood at $23,000 in 2024. An additional $7,500 catch-up contribution is allowed for self-employed workers age 50 or older in 2025 or 2024. If you’re aged 60 – 63 in 2025 you can increase the catch-up contributions to $11,250.

The amount you can make for nonelective employer contributions is based on your net earnings from self-employment after deducting one-half of your self-employment tax and contributions for yourself. Altogether, total contributions, not counting catch-up contributions, are limited to $70,000 for 2025 and $69,000 for 2024.

For tax purposes, a solo 401(k) is treated the same as a traditional 401(k), unless it’s designated as a Roth account. Under traditional 401(k) rules, your qualified withdrawals are taxed at your ordinary income tax rate. A 10% early withdrawal penalty and ordinary income tax would apply to non-qualified withdrawals. Required minimum distributions would kick in beginning at age 70.5.

A Roth solo 401(k) would follow Roth IRA tax rules. That means no deduction for contributions, but qualified withdrawals would be tax-free. There are also no required minimum distributions to worry about.

SEP IRA Pros and Cons

A SEP IRA is a popular retirement savings option for small business owners and self-employed individuals. It offers a straightforward way to contribute to retirement savings with some unique benefits and drawbacks. Understanding the pros and cons of a SEP IRA can help you make an informed decision about whether it’s the right choice for your retirement planning.

Pros of a SEP IRA

High contribution limits: SEP IRAs allow for significantly higher contribution limits compared to traditional IRAs. In 2025, you can contribute up to 25% of your compensation or $70,000, whichever is less. This makes it an attractive option for those looking to maximize their retirement savings.
Tax advantages: Contributions to a SEP IRA are tax-deductible, reducing your taxable income for the year. This can result in substantial tax savings, especially for high-income earners, while allowing your investments to grow tax-deferred until withdrawal.
Flexibility in contributions: Employers are not required to contribute every year, providing flexibility based on business performance. This feature is particularly beneficial for small business owners who may experience fluctuating income levels.

Cons of a SEP IRA

Employer-only contributions: Only employers can contribute to SEP IRAs, which means employees cannot make their contributions. This can limit the ability of employees to increase their retirement savings independently.
Uniform contribution requirement: Employers must contribute the same percentage of salary for all eligible employees, which can be costly if you have a large workforce. This requirement can be a financial burden for businesses with multiple employees.
No catch-up contributions: SEP IRAs do not allow for catch-up contributions for those aged 50 and older. This can be a disadvantage for older individuals looking to boost their retirement savings as they approach retirement age.

A SEP IRA offers a range of benefits, particularly for small business owners and self-employed individuals seeking a tax-advantaged retirement savings plan with high contribution limits. However, the limitations on employee contributions and the uniform contribution requirement may pose challenges for some businesses.

Solo 401(k) Pros and Cons

A Solo 401(k) is a retirement savings plan designed for self-employed individuals and small business owners with no employees. It offers a unique blend of benefits and drawbacks that are important to consider when planning for retirement. Understanding the pros and cons of a Solo 401(k) can help you make an informed decision about whether this retirement savings option is right for you.

Pros of a Solo 401(k)

High contribution limits: Solo 401(k) plans allow for higher contribution limits compared to traditional IRAs. As both the employer and employee, you can contribute up to $66,000 in 2023 if you’re under 50, and even more if you’re older, maximizing your retirement savings potential.
Tax advantages: Contributions to a Solo 401(k) can be made on a pre-tax basis, reducing your taxable income for the year. This can result in significant tax savings, especially for those in higher tax brackets, while also allowing your investments to grow tax-deferred.
Roth option availability: Many Solo 401(k) plans offer a Roth option, allowing you to make after-tax contributions. This means your withdrawals in retirement can be tax-free, providing flexibility in managing your tax liabilities in the future.

Cons of a Solo 401(k)

Complex setup and maintenance: Establishing a Solo 401(k) can be more complex than other retirement plans. It requires more paperwork and administrative responsibilities, including annual filings with the IRS once your plan exceeds $250,000 in assets.
No employee contributions: Solo 401(k) plans are limited to business owners with no employees, which means you cannot offer this benefit to any staff you might hire in the future. This limitation can be a drawback if you plan to expand your business and hire employees.
Potential for higher fees: Some Solo 401(k) plans may come with higher fees compared to other retirement savings options. It’s important to carefully evaluate the costs associated with maintaining the plan to ensure it aligns with your financial goals.

A Solo 401(k) can be a powerful tool for self-employed individuals looking to maximize their retirement savings. However, it’s essential to weigh the benefits against the potential drawbacks, such as complexity and fees, to determine if it’s the best fit for your financial situation.

Bottom Line

Both SEP IRAs and solo 401(k)s can help you sock away money for your later years when you run your own business. Your age, self-employment earnings and business structure may determine which one is best for your retirement goals. Consider the costs and ongoing responsibilities to maintain your account, as well as what you can put into the account as a self-employed business owner. With a little research, you’ll find the right retirement plan for your current and future financial situation.

Tips for Self-Employed Retirement Planning

A financial advisor could help you create a retirement plan for your needs and goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you haven’t done so yet, use a retirement calculator to determine how much money you’ll need to save. Then, compare that to what you’ve saved already. Calculate how much money you’ll need to put away yearly and monthly from your self-employment income to reach your goal.
Consider how you can supplement your retirement savings, too. If you have a high-deductible health plan, for instance, you may be able to save money on a tax-advantaged basis in a Health Savings Account.