Solo 401(k) vs SEP IRA vs SIMPLE IRA: Which is Best for You?

If you’re among the ranks of the world’s self-employed, we salute you. Your choice to invest time and money into a company of your own is evidence of true self-worth (not to get too woo-woo). A profitable business could also pay off tenfold for you one day—we certainly hope so.

Outside of hustling hours, every good mogul needs to think about their long-term financial well-being. Traditional employees have the benefit of an employer-sponsored 401(k), but self-employed people can open a Solo 401(k), SEP IRA, or a Simple IRA as an alternative(s). 

All three retirement accounts have similar benefits, but their differences make each one uniquely fit for certain kinds of entrepreneurs and business owners. Let’s dive into each.

The solo 401(k) is exactly what it sounds like. Sometimes called a one-participant 401(k)—or “uni-k” for short—this plan covers a business owner with no employees. If the individual business owner is married, the solo 401(k) plan will also cover their spouse.  

Solo 401(k) plans have the same rules and requirements as employer-sponsored accounts. The business owner gives themselves a paycheck and, from it, makes 401(k) contributions up to the annual limit. In 2021, the limit is $19,500 or $26,000 for people over 50. The business owner can then turn around and make employer contributions (aka employer matching) up to 25% of their salary.

For example, let’s say Sam owns an S Corporation and pays themselves a salary of $78,000. Every year, they contribute 25% of their salary, or $19,500, to their Solo 401(k). They can then match their own contributions as the employer, bringing their total year’s contributions to $39,000. Pretty sweet, right?

The acronym “SEP” stands for “simplified employee pension.” Self-employed people and businesses of any size can establish a SEP. 

Only employers contribute to SEP IRAs. Annual contributions can’t exceed 25% of the employee's compensation, or $58,000 (in 2021)—whichever is smallest.

Just like the “good-ol’ days” of pensions, the employee is always 100% vested in their SEP-IRA money.

The IRS loves its acronyms. The acronym “SIMPLE” stands for “Savings Incentive Match Plan for Employees.” SIMPLE IRAs provide a way for both employees and employers to contribute to traditional IRAs. 

SIMPLE IRAs were made for small businesses that wanted to avoid the costs associated with opening retirement plans for their employees. (Believe it or not, there are fees required to open, manage, and educate employees on their retirement plans.) SIMPLE IRAs are popular with small businesses that have 100 employees or less.

Employees are always vested in their SIMPLE IRAs. Employers are required to contribute a 3% match of their employees’ salaries, or a 2% non-elective contribution based on the employee’s salary (in the case that the employee doesn’t contribute anything) up to an annual limit of $290,000 for 2021.

Self-employed folks, entrepreneurs, and business owners alike can benefit from opening a retirement account for themselves and their employees. Here’s a look at how all three of these popular options compare:

Biggest appeal

Solo 401(k): Individual entrepreneurs can contribute as both employee and employer, providing an outstanding opportunity to maximize tax breaks on your investment contributions or earnings.

SEP IRA: Owners of any-sized businesses can provide a retirement benefit to all employees (including themselves).

SIMPLE IRA: Small business owners with 100 employees or less can provide a lower-cost retirement benefit that both employers and employees can contribute to.

Who funds them (and how)

Solo 401(k): You, yourself, and—um—you, contribute pre-tax dollars from your revenue, plus after-tax cash from your self-paycheck

SEP IRA: Only the employer; employees can't contribute to a SEP IRA through payroll deductions

SIMPLE IRA: Both employer and employee; funded by employee payroll contributions and/or employer contributions.

How employees qualify

Solo 401(k): This account isn’t meant for your employees—only for self-employed individuals and their spouses.

SEP IRA: Employees qualify when they are 21 or older, earn at least $650 in tax year 2021, and have worked for the same employer in at least three of the past five years.

SIMPLE IRA: There are no age restrictions, but employees must have earned at least $5,000 during any two prior years (they don’t have to be consecutive), and expect to earn at least $5,000 in the current year.

Contribution limits

Solo 401(k): Your total “employer” contributions can't exceed up to 25% of your self-compensation, or $58,000 for the 2021 tax year—whichever is less. (Bump that to $64,500 if aged 50 or older). And as your own “employee,” your additional contributions must max out at $19,500 for the 2021 tax year ($26,000 for employees age 50 or older). Contributions are deductible and aren't required every year.

SEP IRA

• Employer: Up to 25% of the participant's compensation or a maximum of $58,000 for the 2021 tax year—whichever is less. Contributions are deductible and aren't required every year.
• Employee: For the 2021 tax year, up to $6,000 ($7,000 for employees age 50 or older)

SIMPLE IRA

• Employer:
  • Dollar-for-dollar match of employee contributions up to 3% of each employee's compensation (minimum of 1%), OR
  • Contribute 2% of each employee's compensation. Maximum compensation used to determine this contribution is $290,000 for the 2021 tax year.
  • Contributions are deductible and are required every year the plan is in operation.
• Employee:
  • For the 2021 tax year, $13,500 or $16,500 for employees age 50 or older; employees aren't required to contribute in any given year.

Rules for withdrawal

Solo 401(k): You must reach a specified event such as reaching age 59½, death, or hardship withdrawal, or a 10% penalty will probably apply.

SEP IRA: An employee may make a withdrawal at any time, but it will be subject to federal income taxes and a possible 10% penalty if the employee is under age 59½.

SIMPLE IRA: An employee may make a withdrawal at any time, but it will be subject to federal income taxes and a possible 25% penalty if the withdrawal is taken within the first two years of participation, and a possible 10% penalty if it's taken after the first two years.

While these above options are popular ways to invest for retirement amongst the self-employed, you can invest on your own as an individual, too. That may mean opening a traditional or Roth IRA instead of a retirement plan made specifically for small biz owners. Traditional and/or Roth IRAs offer low administrative burden, and the 2021 combined contribution limit is $6,000, or $7,000 for people over 50.

Let’s also not forget the self-directed IRA. Compared to a regular IRA, where your money goes into traditional stocks and bonds, self-directed IRAs are the DIY version for making alternative investments.

The self-directed IRA isn’t without risk—in fact, risk is kind of its middle name. But hear us out: PayPal co-founder Peter Thiel Back used a self-directed IRA to invest $1,164 in PayPal just 22 years ago. Today, that initial post-tax investment is worth more than $5 billion. And since he already paid taxes on it, he won’t have to pay taxes again.

As a self-employed person, you’ve probably already dabbled with risk. We’re not saying you should put every hope for your financial future into a self-directed IRA. But we are saying that people with a comfortable safety net and a higher appetite for risk (in other words, entrepreneurs) should at least consider making alternative investments a small but potentially mighty part of their portfolio.

It’s a little something called diversification. You know this. Business owners understand the notion of having multiple revenue streams. It’s the same for your portfolio. 

We know that self-employed peeps are busy enough running the show. Thankfully, there are a number of platforms today that help you easily put your money where your interests are.

For example, Roofstock lets you invest in tenant-occupied Single-Family Rental (SFR) properties. There’s a $20,000 minimum investment, but the company boasts a 13.22% target return (much better than the average long-term stock market return of 10%). 

Meanwhile, Rally is an investment app that turns high-value, appreciating assets like collectible cars into stocks.

And, of course, if you want to pay it forward and offer smaller amounts of capital to new startups, MicroVentures makes it possible for a minimum investment of $100. Past investment opportunities on MicroVentures have included Airbnb, Lyft, Snapchat, and Spotify.