As self-employment has continued to grow as a career path, so too has the importance of retirement planning. The decision between a SEP IRA or Solo 401(k) carries more weight now than ever, with 2025 bringing adjusted contribution limits and fresh tax considerations.
In this article, we’ll explore both retirement vehicles in depth, comparing their advantages, drawbacks, and eligibility factors—and discuss how Harness can help you plan your retirement more tax-efficiently.
Key takeaways
- Solo 401(k) plans offer dual contribution channels as both employer and employee, allowing maximum contributions of $70,000 in 2025, with additional catch-up provisions for those over 50.
- SEP IRAs provide streamlined administration and flexibility for businesses with employees, though contributions are capped at 25% of compensation up to $70,000.
- Recent tax law changes have introduced enhanced catch-up contributions for ages 60-63, making Solo 401(k)s particularly attractive for professionals in this age bracket.
- Business structure, growth plans, and current income levels should drive the choice between plans, as each offers distinct advantages for different entrepreneurial scenarios.
Table of Contents
- What is a SEP IRA?
- What is a Solo 401(k)?
- Changes in 2025 contribution limits
- Advantages of SEP IRAs
- Drawbacks of SEP IRAs
- Advantages of solo 401(k) plans
- Drawbacks of solo 401(k) plans
- Eligibility factors that shape your decision
- How Harness can help
What is a SEP IRA?
SEP IRAs are a streamlined solution for business owners who want retirement security without the administrative headaches. They’re easy to set up and manage, and allow for significantly higher contribution limits compared to a traditional IRA.
The key thing to understand about a SEP IRA is that all contributions come from you in your role as the employer. For self-employed individuals, this means funding the account from your business, not as an employee. This employer-only funding model is what allows for the attractive contribution limits (the lesser of 25% of an employee’s compensation or $70,000).
That said, the real appeal of a SEP IRA lies in its straightforward nature. It requires minimal paperwork and administrative oversight—a true “set it and forget it” option for retirement planning.
What is a Solo 401(k)?
The Solo 401(k) is essentially the traditional employer-sponsored retirement plan redesigned specifically for owner-only businesses. These plans are exclusively available to business owners and their spouses—creating a powerful savings vehicle for single-member enterprises.
The key advantage of a Solo 401(k) lies in its dual contribution structure, which allows you to contribute as both an employee AND an employer—a feature that can significantly boost your retirement savings, even if your business income is modest. Many providers also offer a Roth contribution option, which lets you build a source of tax-free retirement income—a valuable tool for strategic tax planning.
However, this comes with a trade-off in administrative complexity. Once your plan’s assets reach $250,000, you’re required to file an annual Form 5500-EZ. This adds a layer of oversight that SEP IRAs don’t have, making the Solo 401(k) a more hands-on option.
Changes in 2025 contribution limits
Retirement contribution limits have shifted for 2025, with both SEP IRAs and Solo 401(k)s now having a $70,000 ceiling. Don’t be misled, however, by this seemingly equal cap—there are two very different paths to reaching those maximum contributions.
For SEP IRA holders, the math remains straightforward but potentially limiting. With contributions capped at 25% of compensation (or 20% for sole proprietors), reaching the full $70,000 requires $280,000 in income. This structure can pose challenges for businesses with more modest revenues.
Solo 401(k) plans offer a more flexible approach. You can contribute $23,500 as an employee regardless of income level, creating a solid foundation. You can then add employer contributions on top of that, potentially reaching the full $70,000 at lower income levels than required for a SEP IRA.
Another key distinction lies in catch-up contributions. Solo 401(k)s allow those who are 50 or older to add $7,500 to their contributions, with a special provision for those aged 60-63 that allows an additional $11,250. SEP IRAs don’t offer these catch-up provisions.
Advantages of SEP IRAs
For entrepreneurs juggling the continuous demands of running their business, the administrative simplicity of SEP IRAs offers tremendous value. These accounts operate with remarkable efficiency, involving minimal oversight and paperwork.
When it comes to regulatory requirements, you won’t have to deal with Form 5500 filing obligations, regardless of account size. This perpetual simplicity stands in sharp contrast to Solo 401(k)s, which introduce additional reporting requirements as your assets grow.
Should your business profits fall short of expectations, SEP IRAs also offer flexibility. You can reduce or skip contributions entirely without penalties or additional reporting, providing much-needed breathing room during lean periods.
Finally, unlike Solo 401(k)s, SEP IRAs can smoothly accommodate a growing workforce. While this flexibility means contributing equally for eligible employees, it also means you don’t need a complete plan overhaul as your business expands, saving you headaches down the road.
Drawbacks of SEP IRAs
This equal contribution requirement for all eligible employees can create unexpected financial pressure, however. If you want to maximize your own retirement savings, you’ll need to extend that same percentage contribution to all qualifying staff members—potentially creating substantial additional costs as your team grows.
When it comes to lower-income entrepreneurs, they face a particular challenge with SEP IRAs. The 25% contribution limit effectively requires $280,000 in income to reach 2025’s maximum contribution of $70,000. This is a steep threshold that can place full contribution potential out of reach for many business owners.
The absence of catch-up contributions can also leave older entrepreneurs at a disadvantage. While their Solo 401(k) counterparts can boost savings through additional age-based contributions, SEP IRA holders must work within standard limits regardless of age.
Additionally, access to retirement funds before retirement age is more restrictive with SEP IRAs. Without loan provisions, early withdrawals typically trigger both penalties and taxes, limiting financial flexibility compared to Solo 401(k)s that offer borrowing options.
Beyond this, the standard SEP IRA’s lack of Roth options constrains tax planning strategies. This limitation can impact long-term tax efficiency, particularly for those anticipating higher tax brackets in retirement.
Advantages of solo 401(k) plans
The dual contribution structure of Solo 401(k)s offers a considerable advantage when it comes to maximizing retirement savings. When you contribute as both employer and employee, these plans can reach higher total contributions at income levels where SEP IRAs would fall short—giving you more benefit for your investment.
For entrepreneurs approaching retirement age, catch-up contributions provide a significant boost to savings potential. As mentioned, the special provision for those aged 60 to 63, allowing an additional $11,250 in contributions for 2025, creates an opportunity to accelerate retirement preparation when it’s needed most.
Built-in loan provisions also offer a valuable safety net, allowing access to retirement funds without permanent withdrawal. The ability to borrow up to $50,000 or 50% of your account value provides financial flexibility while keeping retirement savings intact—a major plus when dealing with unexpected situations.
With the availability of Roth contributions in many Solo 401(k) plans, this opens the doors to tax-free growth that can prove highly valuable, especially if you anticipate being in a higher tax bracket later.
Drawbacks of solo 401(k) plans
Once your plan assets cross the $250,000 threshold, Solo 401(k)s introduce a layer of complexity in the shape of mandatory Form 5500-EZ filings. This annual reporting requirement means additional attention and potentially professional assistance to ensure compliance.
The initial setup process also demands more extensive documentation than SEP IRAs. Proper plan establishment often requires dealing with complex IRS requirements and, again, often requires professional guidance to avoid compliance pitfalls.
Another drawback is that business growth can trigger unexpected complications with Solo 401(k)s. Hiring full-time employees beyond a spouse typically invalidates the plan, forcing you to either convert to a different retirement structure or terminate the existing plan—a potential roadblock for expanding your business.
In addition to this, the cost structure of Solo 401(k)s often exceeds that of SEP IRAs. From setup fees to ongoing administration costs and investment expenses, the total financial commitment typically runs higher than simpler retirement options.
Timing constraints add another layer of difficulty, as these plans generally require establishment by December 31 of the tax year for employee deferrals. This stricter deadline leaves less flexibility compared to SEP IRAs for last-minute retirement planning.
Eligibility factors that shape your decision
The structure of your business plays a key role in determining plan suitability. Sole proprietorships, partnerships, and corporations each face specific considerations when evaluating SEP IRAs against Solo 401(k)s, from contribution calculations to tax implications.
When considering workforce dynamics, employee presence becomes a defining factor. While SEP IRAs can adapt to accommodate a growing workforce, Solo 401(k)s generally remain exclusive to owners and their spouses, making your future hiring plans a major factor in this decision.
Age is also a major factor in plan selection. The substantial catch-up provisions exclusive to Solo 401(k)s can tilt the scales decisively for entrepreneurs over 50, particularly those in the 60-63 age bracket with access to enhanced contribution limits.
How Harness can help
Choosing between a Solo 401(k) and a SEP IRA is an important decision you may have to make for your financial future, with each plan offering distinct advantages and trade-offs. While the choice depends on your specific goals, a wise approach is to consult with a tax professional who can analyze your specific situation.
At Harness, we connect individuals and businesses with expert tax and financial advisors who specialize in helping entrepreneurs and business owners. Their expertise ensures you select the optimal retirement vehicle to maximize tax efficiency, providing personalized guidance on all aspects of your financial journey.
Get started with Harness and build a tax-efficient retirement plan that works for you.
Disclaimer:
Tax related products and services provided through Harness Tax LLC. Harness Tax LLC is affiliated with Harness Wealth Advisers LLC, collectively referred to as “Harness Wealth”. Harness Wealth Advisers LLC is a paid promoter, internet registered investment adviser. Registration does not imply a certain level of skill or training. This article should not be considered tax or legal advice and is provided for informational purposes only. Please consult a tax and/or legal professional for advice specific to your individual circumstances. This article is a product of Harness Tax LLC.
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