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Entrepreneurs choose retirement options – SEP IRA or Solo 401(k)?

The SEP IRA and the Solo 401(k) are the self-employed worker version of their more widely known namesake accounts.



Saving for retirement involves many complex decisions, but the complexity is even higher for self-employed Americans who do not have access to a company-sponsored 401(k) plan.

Fortunately, there are two very strong retirement account options available to these entrepreneurs: the SEP (Simplified Employee Pension) IRA and the Solo 401(k).

The SEP IRA and the Solo 401(k) are the self-employed worker version of their more widely known namesake accounts. But there are some important differences, too. Chief among them: These special accounts feature contribution limits that reach as high as $60,000 for 2017 – nearly 10 times the limit of $6,500 per year imposed by normal IRA’s.

But if both account types offer the same enhanced contribution limits, which is the better choice for the discerning entrepreneur?

Under most circumstances, it will “feel” the same to use either a SEP IRA or a Solo 401(k). However, the two accounts are very different in some substantive ways. To begin with, the SEP IRA and Solo 401(k) are governed by entirely different bodies of law, and almost without exception, the Solo 401(k) is substantially more flexible and safer than the SEP IRA. For example:

Want to use the popular “Roth” style of account?

Roth accounts enable you to have totally tax-free income during retirement. With a Solo 401(k), both “Traditional” and “Roth” varieties are available, but the SEP IRA offers only the traditional style of taxation. (To get Roth benefits in a SEP IRA, you’ll have to convert your SEP IRA into a Roth IRA.)

Is your self-employed business structured to minimize the profitability of the business?

It may seem a silly question, but the truth is that many small businesses are structured specifically to minimize the profitability of the company, opting instead for higher wages for the owner. If that’s the case, you’ll be much better off with the Solo 401(k). While both the SEP IRA and Solo 401(k) offer a very high contribution limit of up to $60,000 per year, there’s another limitation to consider: With a SEP IRA, you can only contribute up to $60,000 or 20-25% of your company’s profits, whichever is less. So even if your income is very high, if your company isn’t profitable, you can’t contribute to a SEP IRA.

Do you want to invest your retirement savings in real estate or other alternative assets?

If so, use a Solo 401(k). Investing in alternative assets makes it easy to make errors that the IRS calls “prohibited transactions” which are genuinely fatal and generally irreparable when committed inside of an IRA. But those errors within a 401(k) are much easier and far less expensive to correct.

Does your spouse work with you in in your business?

If so, use the Solo 401(k). This is better for self-employed spouses because both of you can contribute to the same plan, and this enables you to “pool” your retirement savings together to make larger investments jointly.

Frankly, there is not a single substantive reason that one should choose a SEP IRA over a Solo 401(k).

Of course, you should consult with your own financial advisor to make this decision. Most financial advisors will tend towards recommending the SEP IRA simply because it has been available much longer and is more familiar. Additionally, many advisors are actually paid commissions on the basis of the investments performed inside of a SEP IRA. The same is nearly never true of Solo 401(k) plans. Therefore, always be sure to investigate the possibility of a conflict of interest if your advisor recommends the SEP IRA over the Solo 401(k) without being able to clearly justify the reason.

The good news is that either way, self-employed people have great options in the form of both the SEP IRA and the Solo 401(k), and their decision making is made easier by the fact that the Solo 401(k) is an undeniably superior choice.

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

Bryan Ellis is host of Self Directed Investor Talk, America's #1 radio show and podcast for alternative asset investors where his expertise in Self Directed IRA, Self-Solo 401(k) and Turnkey Real Estate Investments help his listeners to build wealth for multiple generations.  Bryan lives in Atlanta, Georgia with his wife Carole and their 4 children.