Solo 401k or SEP Ira ( or something else?)

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
wmd36
Posts: 22
Joined: Tue Nov 29, 2022 4:23 am

Solo 401k or SEP Ira ( or something else?)

Post by wmd36 »

I am a one man business and want to open a retirement plan for my self. I have been looking into my options and these two seem to be good options. The SEP seems to be the easiest to administer and still has high contribution amounts.
Are my contribution limits based solely on my income from the business or also on my wife’s income? We do file jointly. Do dividends and interest income from my existing non ira accounts factor into this equation as well?
Thanks
ThankYouJack
Posts: 5704
Joined: Wed Oct 08, 2014 7:27 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by ThankYouJack »

I've found this helpful to quickly compare - https://www.solo401k.com/calculator/

and if you decide to go with a Solo 401k - https://obliviousinvestor.com/solo-401k ... alculator/
HomeStretch
Posts: 11415
Joined: Thu Dec 27, 2018 2:06 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by HomeStretch »

Your contributions to a self-employed retirement plan, such as a Solo 401k or SEP-IRA, are based on your self-employment earnings.
Lafder
Posts: 4127
Joined: Sat Aug 03, 2013 7:56 pm
Location: East of the Rio Grande

Re: Solo 401k or SEP Ira ( or something else?)

Post by Lafder »

A solo401k is not hard to set up manage.

I found that the total contribution amount is higher for the solo401k because you can contribute as the employer and employee on the same income. You can look this up and see the max contribution for a SEP vs solo401k for the same income approximating what you think you will make.

((Thanks for the calculator link Thankyoujack!))

For a solo401k I need to make 215,000 to max the contribution at 67,500 (I am over 50).
For a SEP, I could only contribute $40,601 for the same income. I would need to make $400,000 income to hit $61,000

Put another way, for 25,000 business income, I can only contribute:
$23,234 to a solo401k
$4,646 to a SEP IRA

This difference in max contributions really makes a difference over years.

Fidelity allows you to roll any existing IRA's or 401k's into a solo401k so you can simplify older holdings.

A solo401k is a retirement account that is only in your name. (If your wife is an employee of your company you could add an account for her, that belongs to her.)

The amount you can contribute is based just on the income earned by you through your self employed business. (You are only allowed to have yourself and a spouse as employee for a solo401k, no other employees). So any non earned income such as dividends does not add to your business income.

If a back door Roth is a possibility, it is better to have a solo401k than a SEP IRA because of the Pro Rata rule. Another reason to do the 401k.

I used to have a SEP and my accountant told me a 401k is more trouble. But I kept reading on here the max contributions would be higher with a solo401k. So I switched even though I was discouraged. And my accountant said "oh, you really can contribute more to a solo401k" Even though she was good at doing my taxes, she was not aware of this detail that bogleheads often mention.

There are a number of reasons that a solo401k beats a SEP in my opinion.
Topic Author
wmd36
Posts: 22
Joined: Tue Nov 29, 2022 4:23 am

Re: Solo 401k or SEP Ira ( or something else?)

Post by wmd36 »

Lafder wrote: Sun Dec 04, 2022 9:23 pm A solo401k is not hard to set up manage.

I found that the total contribution amount is higher for the solo401k because you can contribute as the employer and employee on the same income. You can look this up and see the max contribution for a SEP vs solo401k for the same income approximating what you think you will make.

((Thanks for the calculator link Thankyoujack!))

For a solo401k I need to make 215,000 to max the contribution at 67,500 (I am over 50).
For a SEP, I could only contribute $40,601 for the same income. I would need to make $400,000 income to hit $61,000

Put another way, for 25,000 business income, I can only contribute:
$23,234 to a solo401k
$4,646 to a SEP IRA

This difference in max contributions really makes a difference over years.

Fidelity allows you to roll any existing IRA's or 401k's into a solo401k so you can simplify older holdings.

A solo401k is a retirement account that is only in your name. (If your wife is an employee of your company you could add an account for her, that belongs to her.)

The amount you can contribute is based just on the income earned by you through your self employed business. (You are only allowed to have yourself and a spouse as employee for a solo401k, no other employees). So any non earned income such as dividends does not add to your business income.

If a back door Roth is a possibility, it is better to have a solo401k than a SEP IRA because of the Pro Rata rule. Another reason to do the 401k.

I used to have a SEP and my accountant told me a 401k is more trouble. But I kept reading on here the max contributions would be higher with a solo401k. So I switched even though I was discouraged. And my accountant said "oh, you really can contribute more to a solo401k" Even though she was good at doing my taxes, she was not aware of this detail that bogleheads often mention.

There are a number of reasons that a solo401k beats a SEP in my opinion.
thanks so nuch for this info!! I really apprecaite it
MadDwag
Posts: 133
Joined: Wed Apr 05, 2017 9:07 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by MadDwag »

I'm slowly but surely making my way through Mullaney's new book, Solo 401(k): The Solopreneur's Retirement Account, and it covers this topic. My key takeaways from the Solo 401(k)/ SEP comparison are that 1) the Solo 401(k) would likely allow for more contributions due to the employer and employee arrangement (obviously dependent upon your earnings), and 2) accountants are used to the SEP moreso than the 401(k) so they'll likely try to steer you that way.
User avatar
cchrissyy
Posts: 2355
Joined: Fri May 05, 2017 10:35 pm
Location: SF bay area

Re: Solo 401k or SEP Ira ( or something else?)

Post by cchrissyy »

you haven't said your expected earnings but if they are high enough, the 401k and the SEP will max out to the same number

if you search here for past threads you will see there are important regulatory obligations and penalties to the 401k. one reason i picked SEP is i did not want to worry about that.
60-20-20 us-intl-bond
User avatar
BolderBoy
Posts: 6753
Joined: Wed Apr 07, 2010 12:16 pm
Location: Colorado

Re: Solo 401k or SEP Ira ( or something else?)

Post by BolderBoy »

cchrissyy wrote: Mon Dec 05, 2022 5:19 pmyou haven't said your expected earnings but if they are high enough, the 401k and the SEP will max out to the same number
Is this true?

I thought the i401k allows employER contributions which the SEPIRA does not.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect
User avatar
MP123
Posts: 4084
Joined: Thu Feb 16, 2017 2:32 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by MP123 »

BolderBoy wrote: Tue Dec 06, 2022 11:16 am
cchrissyy wrote: Mon Dec 05, 2022 5:19 pmyou haven't said your expected earnings but if they are high enough, the 401k and the SEP will max out to the same number
Is this true?

I thought the i401k allows employER contributions which the SEPIRA does not.
i401k allows employEE deferrals in addition to the employER contribution that the SEP also allows.

But if business income is high enough ($250k-ish) then the $61k max can be hit with just the ER contribution that both plans allow, and there's no need or room for the EE deferral. So, in this case, the i401k and SEP would have the same maximum contribution of $61k (which is also the max allowed).
User avatar
cchrissyy
Posts: 2355
Joined: Fri May 05, 2017 10:35 pm
Location: SF bay area

Re: Solo 401k or SEP Ira ( or something else?)

Post by cchrissyy »

yeah.
i feel like that employer/ee stuff is often confusing when we're talking about a "one man business" but when you get to the tax forms it gets really simple. i have a schedule C and just double checked last year's forms.
Schedule 1 line 16 Self-employed SEP, SIMPLE, and qualified plans deducted 58k.
this year the limit is 61k and in 2023 it becomes 66k.
60-20-20 us-intl-bond
supalong52
Posts: 653
Joined: Tue Feb 09, 2010 12:51 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by supalong52 »

Another thing to think about is whether you want to do backdoor Roth IRA contributions. Having a SEP hurts you in that regard because you can't make any contributions without paying some taxes if you have pre-tax monies in the SEP. If you have a Solo 401k and no other pre tax IRA monies, then you can make tax free backdoor contributions.
hameshatumkochaha
Posts: 187
Joined: Tue Feb 22, 2011 6:33 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by hameshatumkochaha »

Agree 100% with everything here.
Just a quick question: For the employER contributions, they don't go on anywhere but Sch 1 Part II "Self-employed SEP, SIMPLE, and qualified plans", right? I want to ensure that the amount won't reflect anywhere on Schedule C. Please let me know.
User avatar
cchrissyy
Posts: 2355
Joined: Fri May 05, 2017 10:35 pm
Location: SF bay area

Re: Solo 401k or SEP Ira ( or something else?)

Post by cchrissyy »

hameshatumkochaha wrote: Tue Dec 06, 2022 2:38 pm Agree 100% with everything here.
Just a quick question: For the employER contributions, they don't go on anywhere but Sch 1 Part II "Self-employed SEP, SIMPLE, and qualified plans", right? I want to ensure that the amount won't reflect anywhere on Schedule C. Please let me know.
right, at least in my experience nothing about the SEP contribution goes on schedule C
60-20-20 us-intl-bond
hameshatumkochaha
Posts: 187
Joined: Tue Feb 22, 2011 6:33 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by hameshatumkochaha »

Sorry, I did not ask clearly. I meant to ask about EmployER contributions into 401-k. Please confirm that those (along with the SEP's like you stated above) don't go in anywhere on Schedule C. Thanks!
User avatar
cchrissyy
Posts: 2355
Joined: Fri May 05, 2017 10:35 pm
Location: SF bay area

Re: Solo 401k or SEP Ira ( or something else?)

Post by cchrissyy »

ah, now i see what you meant. sorry i haven't had a solo 401k but hopefully somebody with experience can confirm it.
60-20-20 us-intl-bond
User avatar
MP123
Posts: 4084
Joined: Thu Feb 16, 2017 2:32 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by MP123 »

hameshatumkochaha wrote: Tue Dec 06, 2022 3:11 pm Sorry, I did not ask clearly. I meant to ask about EmployER contributions into 401-k. Please confirm that those (along with the SEP's like you stated above) don't go in anywhere on Schedule C. Thanks!
Yes, a sole proprietor's i401k contributions (ER and EE) as well as any SEP-IRA or SIMPLE-IRA contributions go on Sch 1 line 16.

The deduction on Sch C is for any contribution the sole proprietor makes to their employee's plans.

This is because the owner's contribution to their own plan is still FICA-taxable on Sch SE, while their contributions to an employee's plan are not and so they can be taken as a deduction on Sch C.
hameshatumkochaha
Posts: 187
Joined: Tue Feb 22, 2011 6:33 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by hameshatumkochaha »

Thanks MP123! I read your comment a few times but I remain confused. Here is why...
When someone is a sole-proprietor, he/she is the only employee of the business (except if a spouse is also an employee).
Question 1: Assuming that is accurate, then how can a soler proprietor contribute to an employee's plan that is not the sole proprietor him/her-self?
Question 2: If one can, like you said, then wouldn't that be an EmployER contribution?
Question 3: If one can, like you said, then which Schedule C row number would the deduction be going to?
Trying to understand better with an example:
Say a sole proprietor made $100k, contributed $10k to Roth solo 401k, $5k to the traditional solo 401k, both as EmployEE contribution, then he was additionally eligible for say $18k EmployER contribution (say using Oblivious Investor's calculator) and contributed $7k as EmployER contribution in the traditional solo 401k; then, per my understanding, $10k won't show up anywhere on the taxes, $7k will show up in Schedule 1 Part II, line 16 (for year 2021); right?
Lastly, where would $5k be reported? Also in Schedule 1 Part II, line 16?
Thanks!
User avatar
MP123
Posts: 4084
Joined: Thu Feb 16, 2017 2:32 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by MP123 »

hameshatumkochaha wrote: Tue Dec 06, 2022 10:53 pm When someone is a sole-proprietor, he/she is the only employee of the business (except if a spouse is also an employee).
Question 1: Assuming that is accurate, then how can a soler proprietor contribute to an employee's plan that is not the sole proprietor him/her-self?
Question 2: If one can, like you said, then wouldn't that be an EmployER contribution?
Question 3: If one can, like you said, then which Schedule C row number would the deduction be going to?
For tax related purposes one who is self-employed is not an employee of themselves. I know, it's confusing.

In this context an employee is one who receives a W2. So, although a sole proprietor is self-employed they are not their own employee. Note this is different for an S-Corp where the owner is also a W2 employee of the corporation they own.

A sole-proprietor is the only owner of the business, but they can hire W2 employees just like any other business. Contributions to these employees (if they exist) are what's shown on Sch C.

Note the instructions for Sch C line 19:

https://www.irs.gov/instructions/i1040s ... 29wd0e1604
Line 19
Enter your deduction for the contributions you made for the benefit of your employees to a pension, profit-sharing, or annuity plan (including SEP, SIMPLE, and SARSEP plans described in Pub. 560). If the plan included you as a self-employed person, enter the contributions made as an employer on your behalf on Schedule 1 (Form 1040), line 16, not on Schedule C.
hameshatumkochaha wrote: Tue Dec 06, 2022 10:53 pm Lastly, where would $5k be reported? Also in Schedule 1 Part II, line 16?
Yes, along with the $7k.
ThankYouJack
Posts: 5704
Joined: Wed Oct 08, 2014 7:27 pm

Re: Solo 401k or SEP Ira ( or something else?)

Post by ThankYouJack »

Lafder wrote: Sun Dec 04, 2022 9:23 pm A solo401k is not hard to set up manage.

I found that the total contribution amount is higher for the solo401k because you can contribute as the employer and employee on the same income. You can look this up and see the max contribution for a SEP vs solo401k for the same income approximating what you think you will make.

((Thanks for the calculator link Thankyoujack!))

For a solo401k I need to make 215,000 to max the contribution at 67,500 (I am over 50).
For a SEP, I could only contribute $40,601 for the same income. I would need to make $400,000 income to hit $61,000

Put another way, for 25,000 business income, I can only contribute:
$23,234 to a solo401k
$4,646 to a SEP IRA

This difference in max contributions really makes a difference over years.

Fidelity allows you to roll any existing IRA's or 401k's into a solo401k so you can simplify older holdings.

A solo401k is a retirement account that is only in your name. (If your wife is an employee of your company you could add an account for her, that belongs to her.)

The amount you can contribute is based just on the income earned by you through your self employed business. (You are only allowed to have yourself and a spouse as employee for a solo401k, no other employees). So any non earned income such as dividends does not add to your business income.

If a back door Roth is a possibility, it is better to have a solo401k than a SEP IRA because of the Pro Rata rule. Another reason to do the 401k.

I used to have a SEP and my accountant told me a 401k is more trouble. But I kept reading on here the max contributions would be higher with a solo401k. So I switched even though I was discouraged. And my accountant said "oh, you really can contribute more to a solo401k" Even though she was good at doing my taxes, she was not aware of this detail that bogleheads often mention.

There are a number of reasons that a solo401k beats a SEP in my opinion.
Another benefit (and I don't want to muddy the waters with another Roth vs TDA thread) but the ability to do a Roth employee Solo 401k contribution is nice and could be more favorable for the QBI deduction.
Post Reply