A SEP IRA vs. Solo 401(k) is a terrific option for business owners with few or no full-time employees because employers must fund all employee contributions, proportional to their own. Conversely, Solo 401(k)s are only an option for self-employed individuals with no full-time employees, although they have the same contribution limits, costs and deadlines as SEPs.
When to Use a SEP IRA
A SEP IRA is a great option for small business owners who have up to five employees and want to contribute up to 25 percent of their income (or $56,000, whichever is less). They’re also best used by solopreneurs who expect to eventually hire up to five employees but no more. This is because SEPs require employers to fund contributions for all employees proportional to their own, making it inappropriate for businesses with more than five employees.
When to Use a Solo 401(k)
A Solo 401(k) can only be used by self-employed individuals or small business owners who have no full-time employees. They are structured similarly to traditional 401(k)s and can accommodate additional employees later easily, making it a good option for solopreneurs who expect to eventually hire more than five employees. You can also defer more than 25 percent of your income with a Solo 401(k) up to $56,000.
When to Use an Alternative
As an alternative to both SEPs and Solo 401(k)s, SIMPLE IRAs are best for employers who have more than five employees and are OK with total contributions of $26,000 or less per year. While SIMPLE IRAs have lower contribution limits, they have the same low administrative costs as SEP IRAs but only require employers to match employee deferrals up to 3 percent, rather than totally funding employee contributions themselves.
SEP IRA vs. Solo 401(k) at a Glance
Mutual fund expense ratios: 0.035%-1.5%
Trading costs: $5-$25/trade
Mutual fund expense ratios: 0.035%-1.5%
Trading costs: $5-$25/trade
Self-directed administrative costs: $200-$2,000 per year
|Rules & Deadlines|
|Ease of Use|
How We Determined When to Use a SEP IRA vs. Solo 401(k)
To compare and contrast SEP IRAs and Solo 401(k)s, we considered several factors including contribution limits, cost, ease of administration, rules and deadlines. We also looked at restrictions under each type of plan like mandatory employer contributions and the ability of business owners to adapt each plan to changing circumstances, such as hiring more employees.
First, we recognized that SEP IRAs are better for small businesses with employees since Solo 401(k)s are effectively not an option. However, once you have more than about five employees, a SEP IRA isn’t a good option, and you should use a SIMPLE IRA or Traditional 401(k) instead.
Further, if you’re a solopreneur but expect to hire up to five employees in the future, a SEP is a superb option. This is because with a Solo 401(k), once you hire employees, it converts to a Traditional 401(k) with administration costs that can be higher than the mandatory employer contributions with a SEP, between three and five employees.
While self-employed people can use a SEP, for single-participant companies, we believe that Solo 401(k)s are better for individuals and solopreneurs since Solo 401(k)s have much higher contribution caps than SEP IRAs as a percentage of income and cost relatively the same. Further, if you ever want to hire employees, a Solo 401(k) can be converted to a Traditional 401(k). This also makes it a good option for solopreneurs who expect to grow into a thriving business with a large headcount.
SEP IRA vs. Solo 401(k): Pricing & Features
To compare a Solo 401(k) vs. SEP IRA, we looked at their respective investment options, contribution limits and structure, pricing, rules and deadlines, ease of use and customer service. Based on our research, it’s clear that one option or the other offers an advantage, depending on your situation, typically headcount.
SEP IRA Pricing & Features
SEP IRAs are the obvious preference for small business owners with employees because Solo 401(k)s aren’t an option. They are also the better choice for self-employed individuals expect to hire up to five employees but no more. Some benefits of SEP IRAs include:
The investment options in a SEP IRA are very wide. Typical SEP IRA investment options include:
- Stocks – Shares of individual companies that trade on exchanges or over the counter that can be actively traded within a SEP IRA
- Bonds – Individual bonds issued by companies, countries or municipalities can be traded in a SEP
- Mutual funds – Almost all SEP IRA providers allow for free trades in proprietary funds with additional funds available from independent providers for a fee
- Target date funds – Some mutual funds offered by providers are structured to automatically rebalance as a target retirement date draws closer. Trades in proprietary funds from your provider are typically commission-free with trades from independent providers be charged commissions.
- ETFs – ETFs represent baskets of securities — similar to mutual funds — that trade on exchanges like stocks. Many SEP IRA providers allow investors to trade in these securities for a fee, which is sometimes waived on trades in proprietary funds from your provider.
Even more options are available if you choose to set up a self-directed account through alternative providers. Using these types of accounts, you can more easily invest in alternative assets, including real estate and precious metals and can even get checkbook control for wider investment flexibility. However, this is also possible using a Solo 401(k).
SEP IRA Contribution Limits
SEP IRAs contribution limits are equal to those of Solo 401(k)s and other 401(k)s and much higher than more traditional IRAs. With a SEP, each year you can contribute $56,000 or 25 percent of your pretax income, whichever is less. There is no minimum contribution, so you can skip contributions during bad years. Also, contributions can be made any time prior to your tax-filing deadline (with extensions), so you can wait until it’s time to file your taxes to determine how much you want to contribute.
“It is important to think about how much you can realistically put away. Certain plans allow a higher contribution than a SEP. Also, if you open a SEP IRA, it must be offered to employees. If you want to “customize” your retirement plan, then a SEP IRA may not be the best fit. However, if you are looking for an extremely low cost, low administration plan, this could be a good opportunity to lower that tax burden as you save for retirement.” — Ron Pac, CFP, ChFC, RICP, Financial Planner, Barnum Financial Group
SEP IRAs don’t have typical employer matching like you’d find in a Traditional 401(k). In fact, employee contributions are not allowed in a SEP. Instead, using a SEP, employers are required to fund contributions for all their employees directly proportional to contributions they make for themselves based on annual pay.
This can obviously make SEPs very expensive for employers if you have more than five employees. If you’re under this threshold, however, the low administration costs of a SEP actually make it economical when compared to other options like a Traditional 401(k).
SEP IRA Pricing
SEP IRA costs are extremely low. The major expense for SEPs comes from funding employee contributions. Otherwise, the primary SEP expenses are custodian fees ($25 to $50), mutual fund expenses (0.035 percent to 1.5 percent), and any trading commissions ($5 to $25).
For a self-employed individual, the typical costs of a SEP IRA include:
- Custodian fee – Each year, a SEP IRA provider charges account holders a fee for holding their account. This fee typically starts at $25 to $50 but can be as high as $2,000 for specialty custodians that focus on real estate or other alternative investments.
- Trading commissions – These are as little as $5 per trade for United States equities and $1 per bond for U.S. bond trades.
- Additional fees for wire transfers and other services – It’s not uncommon for SEP IRA providers to charge for cashier’s checks, returned checks and bank wires.
- ETF and mutual fund expense ratios – Mutual funds and ETFs offered through SEP IRA providers can often be purchased without commissions but still charge their own expense ratios that cover trading and management costs. These start as low as 0.035 percent and can exceed 1.5 percent per year. As you invest more in a given fund, the total amount you pay in expenses will increase.
The costs of a SEP IRA can be higher if you choose to set up a self-directed account to invest in things like real estate through an alternative provider. However, these costs are not necessary for a SEP and can vary widely based on what you want to invest in. For more information, check out our article on SEP IRA costs rules, contributions, and deadlines.
Solo 401(k) Pricing & Features
Where SEP IRAs can accommodate employees in addition to a business owner, Solo 401(k)s can only have one participant. Because they don’t have multiple employees, they aren’t subject to the same degree of regulation and can be used more like IRAs than Traditional 401(k)s.
What’s more, if you hire employees later, Solo 401(k)s can automatically transition to Traditional 401(k)s with employee deferrals that you can choose to match rather than being forced to fund employee contributions in a SEP.
Like SEPs, Solo 401(k)s can also offer a large number of investment options, depending on your provider. These options include the following:
- Stocks – Solo 401(k) investors can actively trade shares in most listed companies.
- Bonds – Investors have direct access to thousands of individual fixed income products, such as corporate and municipality debt.
- Mutual funds – Almost any Solo 401(k) provider allows access to many diversified mutual funds from many different mutual fund companies. If your provider offers their own line of mutual funds, you can typically invest commission-free in those funds.
- ETFs – Solo 401(k) account holders can trade in ETFs, which are portfolios of individual securities (like mutual funds) that trade like stocks. Again, if your provider has their own ETFs, they often waive commissions on trades in these funds.
- Target date funds – Some providers offer their own target date funds while others offer some from independent third parties. These funds are designed to shift from stocks to more conservative investments as a target retirement date approaches.
Solo 401(k)s, like SEPs, can be self-directed and can achieve an even greater degree of investment flexibility through a feature called “checkbook control,” which is offered through some online providers. Many Solo 401(k) providers also allow account holders to borrow against 401(k) assets up to the $50,000 maximum allowed by the IRS.
While this feature comes with added costs, it allows Solo 401(k) account holders to invest in almost anything, including real estate. For more information, check out our ultimate guide on Solo 401(k)s for real estate investing.
Solo 401(k) contribution limits are $56,000, which is the same as SEP IRAs. However, under a Solo 401(k) you aren’t limited to contributing only 25 percent of your income. In fact, the limit is more than 90 percent of your income since you still need to pay self-employment tax. This is a terrific advantage for self-employed individuals who make less than about $75,000 per year as it allows them to contribute more than under a SEP IRA.
Under a Solo 401(k) there is no “matching” because there’s only one participant and because employee and employer are the same person. While most 401(k) contributions are broken into employee deferrals, matching and profit-sharing, these are generally consolidated in a Solo 401(k).
However, contribution limits for a Solo 401(k) are the same as under Traditional 401(k)s. If you later hire any employees who become eligible for your 401(k) plan, your Solo 401(k) can automatically convert to a Traditional 401(k) plan, where matching is also not required.
Solo 401(k) Pricing
Because they have only one participant (and that’s the business owner) Solo 401(k)s don’t require the same degree of administration as most 401(k)s. Instead, they can be structured and invested more like IRA alternatives than Traditional 401(k)s that require a record keeper, third-party administrator or annual compliance testing.
Typical Solo 401(k) costs include:
- Custodian fee – Solo 401(k) providers charge a fee for holding accounts that typically range from $25 to $50.
- Trading commissions – Depending on the provider, you can pay as little as $5 for U.S. stock trades and $1 per U.S. bond.
- Additional fees for wire transfers and other services – Many providers charge for cashier’s checks and wire transfers.
- ETF and mutual fund expense ratios – Expense ratios charged by mutual funds and ETFs cover trading and management costs. Fees are automatically deducted and start as low as 0.035 percent but can exceed 1.5 percent per year.
- Administrative costs for alternative providers – Alternative providers that specialize in helping business owners invest in assets like real estate can charge additional administrative costs that can be as high as $2000.
- Loan underwriting fee (if available) – If you choose to borrow against your Solo 401(k) assets, many providers charge a fee for this service. This can be a flat fee of $50 to $200 or a percent of the amount borrowed between 0.1 percent to 1.5 percent.
Remember that you can also find providers that offer self-directed accounts and checkbook control, both of which let you invest in alternative assets like real estate. This comes with added costs that are specific to the provider you work with.
SEP IRA vs. Solo 401(k): Rules & Deadlines
With respect to rules and deadlines, SEP IRAs and Solo 401(k)s are quite alike. In fact, they have more in common with each other than they have with many other types of IRAs and 401(k)s. However, there are a number of differences that should be taken into consideration by any small business owner when deciding which is best.
SEP IRA Rules & Deadlines
The biggest advantage in SEP IRA Rules is that they can be used by small business owners who have employees. However, they are ideal for self-employed individuals who don’t have employees for whom they must fund contributions.
SEP IRAs can be established for a given year any time prior to an employer’s tax-filing deadline (with extensions) for that year. Prior-year contributions are allowed in a SEP, and must also occur before the employer’s tax-filing deadline. For more information on how to establish a SEP, check out our step-by-step guide on how to open a SEP IRA.
Solo 401(k) Rules & Deadlines
The biggest limiting factor for an Individual 401(k) is that it can only be used by businesses that have no full-time employees besides the business owner. Solo 401(k)s can only have one participant, which is why they offer so much flexibility.
Most 401(k)s have earlier filing and contribution deadlines but Solo 401(k) deadlines are more like SEPs than like Traditional 401(k)s. A self-employed individual can set up a Solo 401(k) any time before year-end and can make contributions for a given year any time prior to their tax-filing deadline for that year. For more information on how to establish a Solo 401(k), check out our step-by-step guide on how to open a Solo 401(k).
SEP IRA vs. Solo 401(k): Ease of Use
The ease of use for a Solo 401(k) vs. SEP IRA is another area where there the two options have more in common than not. Neither plan requires much in the way of administration or recordkeeping. Both can easily be self-administered, which is a key advantage for either plan.
SEP IRA Ease of Use
SEP IRAs are incredibly easy to use. A self-employed individual doesn’t need to contribute to one — or even set one up — until their tax-filing deadline, and you can change your contributions from year to year. You can change providers easily for different investment options or better pricing. With a SEP, you can accommodate new employees easily with no change except that you must fund employee contributions proportional to your own.
Solo 401(k) Ease of Use
Solo 401(k)s are far easier to use than Traditional 401(k)s. In this respect, they look more like IRAs than like other 401(k) plans. The biggest difference is that if you have a Solo 401(k) and you hire employees, your plan must transition to a Traditional 401(k). While this process is relatively easy, it includes no requirements for recordkeeping, administration, annual filings and compliance testing.
SEP IRA vs. Solo 401(k): Top Providers
Whether you choose a SEP IRA or Solo 401(k), there are a number of quality providers that you can use. Some providers are particularly good with one option or the other but a few providers have particularly strong offerings for both SEP IRAs and Solo 401(k)s. Some of the top providers for both SEP IRAs and Solo 401(k)s include:
With more than $4.5 trillion in assets under management, Vanguard is the largest mutual fund company in the world. Although client investments are restricted to Vanguard’s in-house mutual funds and target date funds, there are more than 100 investment options to choose from. Each option is professionally-managed and incredibly cost-competitive.
There is almost no administrative charge for either SEP IRAs or Solo 401(k)s with Vanguard with charges limited to mutual fund expense ratios and a modest charge per fund used within your plan. The per-fund fee can even be waived if you have more than $50,000 invested with Vanguard.
TD Ameritrade is predominantly an online trading platform, through which it offers account holders a great degree of investment flexibility through both SEP IRAs and Solo 401(k). Investors can invest cheaply in almost any listed stock or bond as well as ETFs and other instruments. Setup and administration are still easy and very low cost. TD also has offices in many cities around the U.S., which you can visit if you need in-person guidance.
Fidelity is one of the largest diversified financial service companies in the world. In addition to brokerage and investment advisory services, it offers an array of retirement accounts including SEP IRAs and Solo 401(k)s.
Fidelity also offers a number of additional services that make them great for business owners who may have other banking needs or want to invest outside of their retirement account. They can also provide individual investment guidance.
A SEP IRA or Solo 401(k) through E-Trade is ideal for small business owners who want to do a lot of trading in their accounts. E-Trade was started as a discount brokerage, a function that is still core to its operations today. They’ve expanded to meet other needs including retirement accounts like SEPs and Solo 401(k)s, but they also provide account holders with cost-effective trading capabilities and access to their mobile platform to trade from anywhere.
SEP IRA vs. Solo 401(k): Customer Service
Customer service is very similar when comparing SEP IRA to a Solo 401(k). In both cases, customer service is typically handled by the provider that typically holds the account in addition to processing trades and reporting account changes.
SEP IRA Customer Service
SEP IRA customer service is typically handled by the mutual fund company or brokerage firm that holds the account. If you have a self-directed account through an alternative provider, there may be separate customer service issues related to alternative investments.
Solo 401(k) Customer Service
Like SEPs, the source of Solo 401(k) customer service is usually the mutual fund company or broker handling the account. Solo 401(k)s that are self-directed or have checkbook control can offer additional complexity. However, because plans have only one participant, customer service is still relatively straightforward.
Both Solo 401(k)s and SEPs have tremendous benefits for small business owners. Both offer high contribution limits, incredible investment flexibility and almost no administrative costs. While small business owners with employees can’t use Solo 401(k)s, both SEPs and Solo 401(k)s are strong options for the self-employed while a SEP is good for those with between three and five employees.