If you’re self-employed or own a small business, the retirement plan you choose can have a big impact on your finances, both today and tomorrow. Simplified Employee Pension (SEP) IRAs and solo 401(k)s are two popular options designed for business owners with few or no employees.

While they both offer a tax-advantaged way to save – such as through tax-deductible contributions and tax-deferred growth – each plan has some unique features and rules. Which of these retirement accounts could be a better fit? Let’s compare their pros and cons.

SEP IRA Benefits

• Simplicity. If you’re looking for a hassle-free retirement plan, a SEP IRA can be a good choice. These plans are straightforward to set up and manage, with minimal paperwork and reporting requirements
• Generous contribution limits. Compared to a regular individual retirement account (IRA), a SEP IRA allows you to set aside more money each year, helping high-income earners to boost their retirement savings. You can set aside up to 25% of your compensation or up to the annual limit set by the IRS, whichever is less.
• Flexible contributions. You can adjust SEP IRA contributions each year based on your business’s performance, helping your business adapt to fluctuating revenue.
• Employee-friendly plan. If you have employees, you can easily include them in the plan, and contributions made on their behalf are also tax-deductible for your business.

SEP IRA Drawbacks

• Limited to employer contributions. If you have staff, you will need to contribute the same percentage of their compensation to their plans as you contribute to yours, which will increase your overall costs. Employee contributions aren’t allowed.
• No loan option. You can’t borrow money from your SEP IRA, which limits your options in a financial emergency.

Solo 401(k) Benefits

• Higher contribution limits. Solo 401(k)s can offer greater savings potential versus SEP IRAs, letting you contribute as both an employee and employer, plus make additional “catch-up” contributions if you’re over 50.
• Loan option: If you’re in a financial pinch, you can borrow up to $50,000 or 50% of your vested account balance, whichever is less.
• Available for your spouse. If they work for your business, your spouse can also participate in the plan and make contributions.

Solo 401(k) Drawbacks

• Not available for employees. If you have employees other than your spouse, a solo 401(k) won’t work for your business.
• More complexity. Setting up and managing a solo 401(k)s requires more time and paperwork compared to a SEP IRA.
• Deadline for setup. If you’d like to set up a solo 401(k), you’ll need to do so by December 31 for the year in which you want to make contributions.

Bottom Line

While it’s a good idea to discuss your decision with a tax or financial advisor, here are two key takeaways.

First, if you don’t have any employees (besides your spouse), a solo 401(k) can help you set aside more tax-advantaged savings each year through the ability to contribute as both an employer and employee – as well as make catch-up contributions once you’re 50. However, if you do have employees and want a plan that’s simpler to manage, a SEP IRA may be the better choice.

What’s the best retirement savings strategy for you? We’ll help you explore your options.