SEP-IRA vs. Solo 401(k): Which Is Better for Self-Employed Clients? 

Disadvantages of a Solo 401(k)

The plan must be opened by Dec. 31 in order to accept contributions for that year. Employee deferrals generally must be made by Dec. 31, though profit-sharing contributions can be made up to the date the business tax return is filed, including extensions. 

A Solo 401(k) is not available to businesses that have employees other than the owner(s) or a spouse involved in the business. 

Deciding Which Plan Is Better for Your Client

Here are some considerations in helping your small-business owning client decide between a SEP-IRA or a Solo 401(k) for their situation. 

A Solo 401(k) might be the better choice if: 

• The business doesn't have employees other than the owner(s) and spouses involved in the business.
• Your client is willing and able to make employee deferral contributions.
• They want to be able to maximize their combined overall contributions from employee deferrals and employer contributions at a lower level of compensation than with a SEP-IRA.
• Your client's compensation from the business is variable and they want to be able to contribute as much as possible each year.
• They want the flexibility of a Roth option and the ability to take a plan loan if needed. 

A SEP-IRA might be the better option if: 

• The client's business has employees.
• The client wants the flexibility to open and fund the plan up until the date they file the business tax return, including extensions.
• Your client is looking for the option with the least amount of associated paperwork. 

Can a Business Have Both Plans? 

Technically, a business can have both plans as long as there are no employees. As a practical matter, this probably doesn't make sense for a client. The overall contributions cannot exceed the annual limits established by the IRS, and there is no doubling up between the two plans. 

Having both types of plans might make sense in a situation where your client owns one business with employees and has another business with no employees. They could make SEP-IRA contributions for themselves and their employees for that business. 

For example, they might also be involved in a consulting business on a solo basis or perhaps with their spouse. In this case, they could make the employee deferral contribution and some portion of the employer profit-sharing contribution depending upon their income from this business and the level of SEP-IRA contributions made for their other business. 

Both types of plans will have the same restrictions on prohibited investments as an IRA and a 401(k), respectively. Both types of plans can generally be opened at a custodian offering self-directed retirement plans if your client wants to use their retirement account to invest in alternative assets such as investment real estate, crypto and others. 

Your self-employed clients need your guidance in determining the best type of retirement plan for their situation. The SEP-IRA and the Solo 401(k) are two viable options to consider. 

— Related on ThinkAdvisor:

• Tax Law Surprise: A SEP IRA Upgrade for Service Pass-Throughs
• When Should Small Businesses Convert SEPs to 401(k)s?
• Are SEP-IRA Contributions Subject To Self-Employment Tax?

Roger Wohlner is a financial writer with over 20 years of industry experience as a financial advisor.