Why Solo 401(k) is Better Than SEP IRA

So I recently incorporated my investments into an LLC with an S-Corp election.

Having recently FIRE’d, I’m now on an endeavor to pursue investments and real estate to continue to grow my wealth. And I figured the most efficient way to do that is through an LLC instead of putting my own personal assets at risk.

An LLC/S-Corp gives me the opportunity to continue to contribute to a tax-deferred retirement account. Since I’m only 35, I could take advantage of this tax-deferred growth over the next 30 years.

And since I no longer have a job with a 401(k) plan, I have to opt for creating my own 401(k) plan through an LLC.

Why didn’t I choose a SEP IRA? Here are the reasons:

SEP IRA Rules

A SEP is a Simplified Employee Pension. The following are the main points of a SEP IRA:

  • Only employers contribute to the plan. There is no employee contribution.
  • Maximum Contribution Limit of $58,000 or 25% of your annual compensation, whichever is less. If you make $100,000 per year, then you can only contribute $25,000. In order to max out your SEP, your annual compensation would have to be $228,000.

Solo 401(k) Rules

  • Enployees contribute up to a maximum of $19,500 in 2021. Similar to a regular 401(k) at any company.
  • Employers can contribute up to the remaining $38,500 or 25% of your annual compensation, whichever is less. This combined total between the employer and employee contribution equals the maximum $58,000 you can contribute per year.

What makes the Solo 401(k) better is that in order to max out your $58,000 per year, your annual compensation only has to be $154,000 instead of $228,000.

This means you’re running payroll less and paying less in FICA, medicare, and payroll taxes.

Additionally, if you’re running a business, this means you can keep more of your cash in your business instead of being forced to pay yourself out just to reap the 401(k) benefits.

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4 thoughts on “Why Solo 401(k) is Better Than SEP IRA”

  1. Interesting, thank you. In order to contribute to Solo 401(k), you have to generate income as a self-employed? You cannot be a w-2 employee and contribute to Solo 401k? I’m trying to generate a self-employed income, but it is not enough to contribute. Do you have to have a substantial side hustle to benefit? Any thoughts on how to generate more as a self vs w-2?

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    • If you have a 401k with at your main job, I would just go with that since you can’t max out two 401k accounts. And focus your side hustle into maxing your Roth IRA if you can.

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