Roth SEP IRA vs Roth Solo 401(k): Choose Wisely for Your Small Business Retirement Plan
Start with the Retirement Planning Guide, then compare the Roth IRA guide and retirement-plan overview. A Roth SEP IRA and a Roth Solo 401(k) differ in eligibility, contributions, administration, employee rules, and provider support. The IRS one-participant 401(k) guidance explains the federal rules for owner-only plans.
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.