The Solo 401k Vs SEP IRA For Self-Employed Retirement Planning

Solo 401ks and SEP IRAs have both been around for awhile now. Previously, SEP IRAs were considered better only because they had lower administration cost and fees.

However, in recent years, competition among brokerages has made administration cost and fees much lower for Solo 401ks. Most brokerages no longer have fees, aside from for the initial setup.

This means that you, the self-employed business owner or real estate investor, are able to choose the retirement plan that's best for you based solely on the merits. Let's take a look at each.

What Is a Solo 401k Plan?

A Solo 401k plan is an IRS-approved retirement plan, which is suited for business owners who do not have any employees. These include consultants, freelancers, yoga instructors, Uber drivers ... and of course our favorite clients: real estate investors.

The Solo 401k, as its name implies, is a plan designed for one person who is a business owner. You can include your spouse on the plan if you have one. For example, a Solo 401k Plan allows you and your spouse to contribute a combined $60,000 annually.

Note: If you REALLY want to learn everything there is to know about the self-directed Solo 401(k), join our Tax, Legal, & Asset Protection Secrets For Real Estate Investors Facebook Group. Once you're in, go to "Units" and look for the Solo 401(k) Unit, where you'll find the "Know More Than Your Attorney" book by Scott Smith. It's 117 pages and nearly 40,000 words but designed to be skimmable so you can find exactly what you're looking for.

9 Reasons Why a Solo 401k is Better For Self-Employed Business Owners Than a SEP IRA 

1. You can open a Solo 401k at any bank.

With a Solo 401k, the 401k bank account can be opened at any local bank or trust company. However, in the case of a Simplified Employee Pension (SEP) IRA, a custodian is required to hold the IRA funds, which will eat into your bottom line whether your investments gain or lose.

2. Roth features are available.

A Solo 401k plan contribution can be made in pre-tax or Roth (after-tax) format. In the case of an SEP IRA, contributions can only be made in pre-tax format.

3. No annual paperwork.

With a Solo 401k, there is no annual paperwork required if your plan has less than $250,000 in plan assets.

4. You can use non-recourse leverage tax free.

With a Solo 401k Plan, you can make a real estate investment using non-recourse funds without triggering the Unrelated Debt Financed Income Rules and the Unrelated Business Taxable Income (UBTI or UBIT) tax.

However, the non-recourse leverage exception is only applicable to 401k qualified retirement plans and does not apply to IRAs. In other words, using a SEP IRA to make a real estate investment involving non-recourse financing would trigger the UBTI tax.

5. You can reach your maximum contribution limit quicker.

A Solo 401k includes both an employee and profit sharing contribution option, whereas, a SEP IRA is purely a profit sharing plan. Business owners with a Solo 401k plan can contribute to their plan both as owners and employees in two ways:

  1. Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
    • $18,000 in 2016 and 2017, or $24,000 in 2016 and 2017 if age 50 or over.
  2. Employer non-elective contributions up to:
    • 25% of compensation as defined by the plan.

Note: Total contributions cannot exceed $54,000 unless catch up contributions are used by those over age 50.

6. You don't need an LLC.

With a Solo 401k Plan, the plan itself can make real estate and other investments without the need for an LLC.
Since a 401k plan is a trust, you can be the trustee on behalf of the trust and can take title to a real estate asset without the need for an LLC.

7. Better creditor protection.

 A Solo 401k Plan offers you greater creditor protection than a SEP IRA. The 2005 Bankruptcy Act protects all 401k Plan assets from creditor attack in a bankruptcy proceeding.

8. Tax free loan option.

With a Solo 401K Plan you can borrow up to $50,000 or 50% of your account value in the form of a loan for any purpose. If you tried to borrow money using a SEP IRA, it would be considered a prohibited transaction.

9. No catch up contributions.

Catch-up contributions allow you to make larger contributions than normal if you qualify. SEP IRA's do not allow for catch-up contributions.

With a Solo 401k Plan you can make a contribution of up to $54,000 to the plan each tax year ($60,000 if the participant is over the age of 50).

The Drawback of a Solo 401k

The only drawback to a Solo 401k is that there is slightly more paperwork required to initially set one up than a SEP IRA.

But investing requires more than just money, it also requires time. So what if a Solo 401k takes an extra hour or two to set up? That's time well spent.

Contact us or explore our Solo 401k offering if you're interested in learning more about a Solo 401k plan.

Last Updated: 
October 31, 2017

Scott Royal Smith is an asset protection attorney and long-time real estate investor. He's on a mission to help fellow investors free their time, protect their assets, and create lasting wealth.

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