Updated 01/26/2023
For self-employed individuals, SEP IRA and Solo 401k accounts are both popular business retirement plans. You will find that these retirement plans are set up under different sections of the tax code. Because these plans have some similarities they can be confused with one another. There are several key differences between them.
CONTRIBUTIONS:
The SEP allows the business to contribute 25% of business income. This is a pre-tax contribution. The max contribution for 2023 is $66,000.
The Solo k allows a business contribution and a personal contribution. The max contribution is $66,000 for 2023 combined if under age 50. The business contribution can only be pre-tax. The max business contribution is 25% of business income. The max personal contribution is $22,500 ($30,000 if over age 50). The combined business and personal contribution would be $73,500. The personal contribution can be either pre-tax or after-tax.
Consider two scenarios. Your business income is $265,000. 25% of that is $66,250. The most you can contribute is $66,000. You could not also put the $22,500 personal contribution in.
Now, consider if the business income is $150,000. 25% of that is $37,500. You could still make the $22,500 personal contribution for a total amount of $60,000
The Solo k will allow you to contribute more if the business income contribution does not hit $62,000.
If you have access to multiple 401(k) plans through different employers, you are still limited to the total employee contribution amount for the year.
You should always check on the current contribution limits for the year you want to make the contribution as they often change.
EMPLOYEES:
You can have full-time employees and use a SEP IRA. You must make IRA contributions for the employee.
The Solo k does not allow you to have any full-time employees besides the company owners or spouses of the owners. If you hire a full-time employee, you cannot contribute to the Solo k anymore and must close the Solo k down and move the assets to a different retirement plan.
TAKING A PERSONAL LOAN:
The SEP IRA does not allow you to take a personal loan. No IRA allows this.
The Solo k allows you to take a personal loan. The max is $50,000 or 50% of the cash value of the Solo k. The loan must be paid back over 5 years with periodic payments. If the loan is not paid back timely, it is considered a taxable distribution.
You can make a loan to other non-prohibited parties from either the Solo k or the SEP.
UNRELATED DEBT FINANCED INCOME TAX (UDFI):
UDFI is a tax when a SEP IRA (or any IRA) borrows money or invests in a business that is borrowing money. This is usually done when buying real estate.
The Solo k is generally exempt to this tax.
UNRELATED BUSINESS INCOME TAX (UBIT):
UBIT is a tax when a retirement plan invests into a business. Both the SEP and the Solo k are subject to this tax.
COSTS AND RESPONSIBILITIES:
You will pay a $50 set up fee and the first year’s annual fee of $275 to set up the SEP. Once the plan is established, you do not have any annual IRS reporting requirements.
You will pay the $50 set up fee, the first year’s annual fee of $275 ($550 for a husband and spouse) and a $400 Plan Binder fee for the Solo k. You will be required to file necessary tax documents with the IRS, such as the 5500EZ. The annual fee rises to $325/ year if holding both pre-tax and after-tax funds.
When the tax code is changed for 401k plans, you will need an updated Plan Binder. That will cost $400 (or whatever the current cost is at that time). This is not a yearly cost; it is only when the tax code regarding 401 ks are changed.
FINAL THOUGHTS:
uDirect IRA Services, LLC is not a fiduciary and does not render tax, legal, accounting, investment, or other professional advice. If tax, legal, accounting, investment, or other similar expert assistance is required, the services of a competent professional should be sought. We do not endorse any particular investment. Rather we offer educational information so you can make an informed investment decision.
You should always consult a tax professional when deciding between retirement plans or any decision regarding the plan including contributions. Feel free to contact us if you have questions about this or any IRA related topic. We can be reached at 866-447-6598 or info@uDirectira.com.
As an IRA administrator, uDirect IRA Services does not affiliate itself or make any recommendations to any person or entity associated with investments of any type (including financial representatives, investment promoters or companies, or employees, agents or representatives associated with these firms). uDirect IRA Services is not responsible for and is not bound by any statements, representations, warranties or agreements made by any such person or entity and does not provide any recommendation on the quality profitability or reputability of any investment, individual or company.
Reach out to us at info@uDirectIRA.com to set up a consultation to go over any of your self-directed questions.
