The SEP IRA and Solo 401k are both business retirement plans. We will take a look here at how the plans differ. For example, these plans are set up under different sections of the tax code. While they have some similarities, there are several key differences between them.
The SEP IRA allows the business to contribute the lesser of 25% of business income or (for 2020 $57,000 and for 2021 it is $58,000). This employer contribution is a pre-tax contribution.
The Solo 401(k) allows a business contribution and a personal contribution. The max business contribution is the lesser of 25% of business income or $57,000 for 2020 combined ($58,000 for 2021). The business contribution is pre-tax. The maximum personal contribution as a participant of the plan is $19,500 ($26,000 if over 50). The personal contribution can be either pre-tax or after-tax (Roth).
Consider two scenarios to help understand the difference between SEP IRA and Solo 401k.
- Your business income in 2020 is $250,000. 25% of that is $62,500. The most you can contribute is $57,000. You could not make the $19,500 personal contribution.
2. Now, consider if the 2020 business income is $150,000. 25% of that is $37,500. You could still make the $19,500 personal contribution for a total amount of $57,000.
The Solo 401(k) will allow you to contribute more if the business income contribution does not hit $57,000. This is because part or all the personal contribution could be made as well. The combination of the two is $57,000 for 2020.
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. If you hire a full-time employee, you cannot contribute to the Solo(k) anymore.
TAKING A PERSONAL LOAN:
The SEP IRA does not allow you to take a personal contribution. No IRA allows this.
The Solo(k) allows you to take a loan. The max is the lesser of $50,000 or 50% of the cash value of the Solo(k).
You can make a loan to other people from either the Solo(k) or the SEP just if the borrower is not a disallowed party.
UNRELATED BUSINESS INCOME TAX (UBIT) and UNRELATED DEBT FINANCED INCOME TAX (UDFI):
UBIT is a tax when a retirement plan invests into a business. Both the SEP and the Solo(k) are subject to this tax.
When a Solo(k) uses non-recourse debt for the acquisition of a property or for property improvement, typically no UDFI tax is due. Unlike the Solo(k), the SEP is subject to UDFI.
You can read about both these taxes HERE. Best to consult your tax advisor or uDirect when you have specific UBIT/UDFI questions.
COSTS AND RESPONSIBILITIES OF SEP IRA and Solo 401k:
The SEP has a $50 set-up fee plus 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. The tax reporting and record-keeping are included and are handled by the custodian.
The Solo(k) also has a $50 set-up fee plus the first year’s annual fee of $275 ($550 for a husband and spouse). There is a $300 Plan Binder fee for the Solo(k). As trustee of the plan, you are required to file necessary tax documents with the IRS, such as the 5500EZ.
When the tax code is changed for 401k plans, you will need an updated Plan Document. There is no charge for this. The updated Plan Document is only needed when the tax code regarding 401 k’s are changed.
Always consult a tax professional when deciding between retirement plans or any decision regarding a SEP IRA or Solo 401k. 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.