Roth SEP IRA vs Roth Solo 401(k)

Roth SEP IRA vs Roth Solo 401(k)

Roth SEP IRA vs Roth Solo 401(k): Choose Wisely for Your Small Business Retirement Plan

After the introduction of the Secure Act 2.0, small business retirement plans witnessed significant enhancements, particularly concerning Roth accounts. This article will compare five crucial points between Roth SEP IRA and Roth Solo 401(k) to help you make an informed decision on which one to choose.

Simplicity: SEP IRA Takes the Cake

When it comes to setting up these two retirement plans, the SEP IRA is more straightforward with fewer documents to complete. In contrast, a Solo 401(k) involves either a prototype plan or a custom plan, the latter requiring additional paperwork and expenses. Additionally, once your Solo 401(k) balance exceeds $250,000, you must file Form 5500, further complicating matters.

Maximum Contributions: Solo 401(k) Shines with Employee Deferrals

The Solo 401(k) allows for employee deferrals, while the SEP IRA only has employer contributions. This means you can contribute more to a Solo 401(k) than a SEP IRA, given the same income. However, both plans have limits, and once you reach them, the difference between the two becomes less significant.

Mega Backdoor Strategy: Solo 401(k) Offers Greater Flexibility

The Solo 401(k) is more flexible in terms of converting funds to a Roth account. While you can convert from a SEP IRA to a Roth IRA, you cannot make non-deductible contributions to the former. Moreover, you must consider the pro-rata rule with a SEP IRA, which is not a concern for Solo 401(k) conversions.

Catch-up Contributions: Solo 401(k) Strikes Again

Catch-up contributions are only available for Solo 401(k) plans, increasing the maximum amounts you can contribute for 2022 and 2023. Unfortunately, SEP IRAs do not offer catch-up contributions as they only have employer-funded contributions.

Employees: A Deciding Factor

If your small business has eligible employees, the SEP IRA is your only option as Solo 401(k) plans are meant for owner-only businesses.

Although the Secure Act 2.0 has introduced various changes, broker-dealers are still working out the kinks and awaiting further guidance from the IRS. Consequently, the actual implementation of these changes may take some time.

Ultimately, the choice between a Roth SEP IRA and a Roth Solo 401(k) will depend on your unique circumstances, such as the simplicity of setting up the plan, maximum contributions, flexibility in converting funds to Roth accounts, catch-up contributions, and employee eligibility. Analyze your specific situation, and choose the plan that best aligns with your goals and needs.