Solo 401k vs SEP IRA: Which Retirement Plan Is Better for You?

Planning for retirement is a crucial step in securing your financial future, especially for doctors and other high W2 earners.

If you’re self-employed, you may have additional options besides traditional employer-sponsored 401(k) plans.

Understanding the various retirement plan choices can help you make informed decisions about your financial goals.

From solo 401(k)s to SEP IRAs, each option has its advantages and considerations. By exploring these alternatives, you can find the right fit for your unique situation and maximize your retirement savings potential.

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Retirement Plan Options for Self-Employed Doctors with 1099 Income

As a self-employed doctor with 1099 income, you have several retirement plan options to consider. The 401k, solo 401k, and SEP IRA are popular choices, each offering unique tax advantages for your retirement savings.

401k

The 401k plan allows you to contribute a portion of your income on a pre-tax basis. If you’re the sole employee of your practice, a solo 401k might be more suitable, offering higher contribution limits and potential cost savings.

SEP IRA

The SEP IRA is another option, particularly appealing if you have a few employees. It’s simpler to set up and maintain compared to a 401k. Recent changes now allow for Roth contributions in both 401k and SEP IRA plans, potentially benefiting high-income earners like yourself.

Let’s break each down in even more detail…..

What is a 401k Plan?

A 401(k) plan is a retirement savings account that allows you to set aside money for your future while enjoying tax advantages. These defined contribution plans mean the amount you save depends on how much you and, in some cases, your employer contributes.

Types of Contributions

You can contribute to a 401(k) in two ways:

Pre-tax Contributions: Money is deducted from your paycheck before taxes and goes into a traditional 401(k). Taxes are deferred until you withdraw the funds in retirement.
Post-tax Contributions: Money is contributed after taxes and goes into a Roth 401(k). Withdrawals during retirement are tax-free, provided you meet the qualifying criteria.

2025 Contribution Limits

The IRS sets annual limits for how much you can save in a 401(k):

Employee Contributions: Up to $23,500 for 2025.
Catch-up Contributions: An additional $7,500 if you’re 50 or older.
Total Contributions: Including employer contributions, the maximum is $70,000 per year.

Types of 401(k) Plans

There are different kinds of 401(k) plans designed to meet various needs:

Standard 401(k): Offered by employers of all sizes.
SIMPLE 401(k): Tailored for small businesses with 100 or fewer employees.
Solo 401(k): Ideal for self-employed individuals or small business owners without employees.

Advantages of 401(k) Plans

401(k) plans provide several benefits, including:

Tax-deferred Growth: Investments grow tax-free until you withdraw them.
Employer Matching: Some employers match a percentage of your contributions, essentially giving you additional funds.
Higher Contribution Limits: Compared to Individual Retirement Accounts (IRAs), 401(k) plans allow you to save more annually.

Important Considerations

Early Withdrawals: Taking money out of a 401(k) before age 59½ can lead to penalties and taxes.
Required Minimum Distributions (RMDs): Starting at age 73, you must withdraw a certain amount from your 401(k) annually, which will be subject to taxes.

Why 401(k) Plans Are Essential

A 401(k) can be a powerful tool in your retirement strategy. It helps you build a solid nest egg while potentially reducing your current tax burden.

To maximize its benefits, consider how it fits into your broader financial goals and explore employer contributions to boost your savings.

What Is a Solo 401(k)?

A Solo 401(k) plan is designed for self-employed individuals or those with 1099 side income who work alone or with their spouse. It offers similar benefits to traditional employer-sponsored plans but gives you full control over its management.

Eligibility Requirements

To qualify for a Solo 401(k):

You cannot have employees other than your spouse or minor children.
If you employ others, consider alternative plans like a standard 401(k) or SEP IRA.

Dual Role: Employee and Employer

With a Solo 401(k), you play two roles:

As an Employee: You can contribute up to 100% of your earned income.
As an Employer: You can add an additional 20-25% of your compensation, depending on your business structure.

Who Benefits from a Solo 401(k)?

This plan is ideal for:

Self-employed individuals
1099 contract workers
Small business owners without employees
Freelancers and consultants
Professionals with side businesses

Tax Benefits of a Solo 401(k)

Pre-tax Contributions

Tax Treatment: Deductible now
Benefits: Reduces current tax liability and allows for tax-deferred growth

Roth (Post-tax) Contributions

Tax Treatment: Taxed now
Benefits: Grows tax-free and allows for tax-free withdrawals in retirement

Employer Contributions

- Tax Treatment: Deductible
- Benefits: Lowers your business’s taxable income

Contribution Type	Tax Treatment	Benefit
Pre-tax	Deductible now	Lower current taxes
Roth	Taxed now	Tax-free growth
Employer	Deductible	Reduces business taxes

Contribution Limits for 2025

The IRS sets annual caps to maximize your savings:

Employee Contributions: $23,500 (plus $7,500 catch-up if aged 50+).
Total Contributions (Employee + Employer): Up to $70,000 for 2025.

With its high contribution limits and tax advantages, this plan is a powerful tool for building long-term wealth while reducing your tax burden today.

Why Choose a Solo 401(k)?

A self-employed 401(k) plan offers significant advantages, making it one of the most powerful retirement savings options for entrepreneurs, freelancers, and consultants.

#1. High Contribution Limits

Previously discussed.

#2. Compatibility with Backdoor Roth IRAs

Self-employed 401(k) plans do not interfere with Backdoor Roth IRA strategies. Unlike traditional IRAs, funds in a 401(k) are excluded from the pro-rata rule when converting to a Roth IRA, preserving this valuable tax-saving option.

Catch-Up Contributions for Late Savers

If you’ve started saving later in life, a solo 401(k) helps you make up for lost time. Those aged 50 or older can contribute an additional $7,500, giving you a boost toward your retirement goals.

Roth Contribution Options

Many solo 401(k) plans offer Roth options. This allows you to:

Make after-tax contributions.
Enjoy tax-free growth.
Withdraw funds tax-free in retirement.

Additionally, you may have the opportunity to perform a Mega Backdoor Roth conversion or roll over funds into a Roth IRA, enhancing your tax diversification strategy.

Ideal for Multiple Income Streams

If you have income from a side business, consulting work, or freelance gigs, these plans allow you to maximize savings across your earnings.

Key Advantages of a Solo 401(k)

High Contribution Limits: Up to $70,000 annually in 2025.
No Impact on Backdoor Roth IRAs: Pro-rata rule is not affected.
Catch-Up Contributions: Extra $7,500 for those 50 or older.
Roth Options: Enables tax-free growth and withdrawals.
Great for Side Income: Helps maximize savings from additional earnings.

How SEP IRA Plans Work

Tax Benefits of SEP IRAs

SEP IRAs offer significant tax advantages for business owners and self-employed individuals. Contributions to traditional SEP IRAs are tax-deductible, which reduces your taxable income for the year.

Additionally, earnings in the account grow tax-deferred until withdrawal, making this plan attractive for long-term savings.

For 2025, you can contribute up to 25% of each eligible employee’s compensation or $70,000, whichever is less. This high contribution limit makes SEP IRAs a strong option for high-income earners looking to maximize retirement savings.

Roth SEP IRAs

Roth SEP IRAs, a newer option, offer unique tax benefits:

Contributions are made with after-tax dollars.
Qualified withdrawals in retirement are tax-free.

This can be particularly advantageous if you expect to be in a higher tax bracket in retirement.

SEP IRAs and Backdoor Roth IRA Strategy

For high-income earners, it’s important to consider how a SEP IRA might affect a Backdoor Roth IRA strategy.

The Pro Rata Rule

Traditional SEP IRA contributions are subject to the IRS’s Pro Rata rule, which requires you to account for all pre-tax IRA balances when converting to a Roth IRA. This can lead to unexpected tax liabilities if you have significant pre-tax balances.

Roth SEP IRA as a Solution

Making Roth contributions to a SEP IRA may help you avoid complications with the Pro Rata rule while still benefiting from high contribution limits.

Benefits of Opting for a SEP IRA

Simplicity and Cost-Effectiveness

SEP IRAs are easy to set up and maintain. Unlike Solo 401(k)s, they don’t require annual filings, even when account balances exceed $250,000.

Flexibility in Contributions

You can adjust or pause contributions based on your business’s financial situation, making SEP IRAs a good choice during lean years when cash flow is tight.

Separation from 401(k) Limits

SEP IRA contributions don’t interfere with your 401(k) limits. If you also participate in a 401(k) plan through a full-time job, you can maximize savings from both sources independently.

Key Advantages of SEP IRAs

Ease of Management: Minimal administrative burden.
Lower Costs: No annual filings required.
Flexible Contributions: Adjust contributions based on income.
Compatibility: Combine with other retirement accounts.

A SEP IRA is particularly well-suited for small business owners or self-employed individuals who value simplicity and want to avoid complex reporting requirements.

How to Choose Between a 401(k) and a SEP IRA

When deciding between these two plans, it’s essential to evaluate their features based on your specific needs.

Feature	401(k) (2025)	SEP IRA (2025)
Contribution Limits	Up to $70,000	Up to 25% of income or $70,000
Employee Contributions	Yes	No
Roth Option	Available	Available (new)
Loan Option	Available	Not available

When to Choose a Solo 401(k)

A Solo 401(k) is ideal if:

You have no employees other than a spouse.
You want to maximize contributions as both an employee and employer.
You prefer flexibility with Roth and pre-tax contribution options.

When to Choose a SEP IRA

A SEP IRA is a better choice if:

You have employees, as contributions must be made for all eligible staff.
You value simplicity and lower administrative costs.
You want a plan that doesn’t require annual filings.

Tax Considerations

Both plans offer tax-deductible contributions, but only a Solo 401(k) avoids the Pro Rata rule, making it more compatible with Backdoor Roth IRA strategies.

Evaluating Your Needs

Future Hiring Plans: If you plan to hire employees, a SEP IRA might be easier to manage.
Income Level: If you earn enough to maximize a SEP IRA, its simplicity may appeal to you.
Flexibility: A Solo 401(k) offers greater options for contributions and tax planning.

Final Steps

Align your choice with your long-term financial goals, including Backdoor Roth IRA strategies if applicable.

Consult with a financial advisor or tax professional to evaluate your options and make an informed decision tailored to your needs.

FAQs

1. What is the better option for self-employed people: Solo 401(k) or SEP IRA?

The better option depends on your specific needs. A Solo 401(k) is often the best retirement plan for self-employed individuals or sole proprietors who want higher contribution limits and flexibility, including elective deferrals and Roth accounts. A SEP IRA, on the other hand, is simpler to manage and ideal for small-business owners with employees. Consider factors like administrative burdens, income taxes, and eligibility to choose the right retirement plan.

2. Can I invest in mutual funds with a Solo 401(k) or SEP IRA?

Yes, both Solo 401(k) plans and SEP IRAs allow you to invest in mutual funds, among other retirement savings vehicles like stocks, bonds, and ETFs. The specific investment options depend on the financial institution you choose to manage your plan assets. Be sure to review the past performance of any investments and consult with a professional for investment advice.

3. What are the annual contribution limits for Solo 401(k) and SEP IRA plans?

For 2025, the Solo 401(k) annual contribution limit is $70,000, which includes employee deferrals and employer contributions. An additional catch-up contribution of $7,500 is available for those aged 50 and older.

For SEP IRA plans, contributions are limited to 25% of net earnings, up to a maximum of $70,000. The Internal Revenue Service (IRS) adjusts these limits annually, so it’s essential to stay informed.

4. How do SEP IRA plans work for sole proprietorships or independent contractors?

SEP IRAs are designed for small-business owners and self-employed individuals, including sole proprietors and independent contractors. Contributions are based on a percentage of net earnings and are tax-deductible, which reduces your income taxes for the year. However, if you have eligible employees, you must contribute the same percentage for them as for yourself, increasing your administrative responsibilities.

5. What are the key differences between a Solo 401(k) and a Traditional IRA?

Solo 401(k): Higher contribution limits, elective deferrals, Roth account options, and the ability to act as both employer and employee, making it a more robust retirement savings vehicle.
Traditional IRA: Lower annual contribution limits ($7,500 for 2025, including catch-up contributions), limited to pre-tax contributions, and no employer contributions.

Solo 401(k) plans are often the best choice for self-employed people looking for higher limits and flexibility, while Traditional IRAs are simpler and work well for those starting small.