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.
4 thoughts on “Why Solo 401(k) is Better Than SEP IRA”
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?
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.
Curious, what did you do before retiring?
Hi Sam, I mostly worked in Finance and Engineering for my entire career.