SEP-IRA vs. Solo 401k?

Welcome to financial planning for tech professionals and

entrepreneurs, the Morton podcast.

I'm re I'm like rebranding this podcast a little bit.

We'll see it goes, but tips and tricks and strategies for

financial planning today's show.

super excited to welcome back.

Megan Russell.

She is the chief operating officer at Marotta wealth manager.

She's written over 700 financial articles.

can be found on Marotta on money.com.

Megan, welcome back to the show.

thanks for having me.

Now.

We can have our geeky financial planning party.

Yeah, that's right.

That's right on a Friday afternoon is when we're recording this and

it is great to connect with Megan.

And we were just chatting before the show here about great topics,

including today's, which is.

SEP IRAs versus solo.

401k is to have big shootout between these two employer retirement plans.

It caught my eye because Megan wrote a recent article on Marana on money.com.

That was fantastic.

And so I thought, oh, let's have her on the show and talk about

this for our listeners, because a of those entrepreneurs, tech

professionals have side hustles or full-time jobs where they want.

to set up Employer retirement plans.

of course there's a few options, including the SEP IRA and the 401k.

So Megan, bottom line up front, if you are an entrepreneur and you've

got your own business, which of these are you going to set up for yourself?

Every business a 401k.

That's my motto.

So I pay, I picked the 401k.

Pick the 401k.

All right.

So that was good episode.

guys.

We'll see you next data.

there's definitely some nuances right?

Between these two pros and cons.

So we're going to dive into those and, but before we do Megan, why do you say

that every business deserves a 401k.

Every business deserves a 401k because it's of the best

ways for you to save just large amount of retirement money.

You just to put so much more money into a 401k.

I want to add that the debate a solo 401k and a SEP IRA is for

businesses that have one employee.

So if you have more than one employee, you can still have a SEP IRA.

But at that point, really, you should do the 401k.

There's so many more anyways, but it's not at that point, a solo

401k, they have the same rules, but there's a little bit of nuance

where when you're the only employee, you get some special other roles.

Anyways.

So just wanted to add that clarification upfront

Yeah, definitely.

So there might be few different things as we talk about it, we might

lose track a little bit you could use a SEP IRA and a 401k if you

have employees, but today, mostly we're talking about solo individual.

the SEP IRA for your solo business or the solo 401k

Yeah, For you alone.

It's also sometimes

called an

individual.

401k is anybody's what is that one?

Anyways.

Yeah,

yeah.

they come by different names, right?

And because you're the only employee in this context that we've

set up the employer contribution is the focus of kind of both of those accounts.

You've got the, as an employer, you get to put money into 401k or.

SEP IRA, or in case, solo 401k plans for the benefit of employees in this case.

You, and normally if you were an employee of a company, you wouldn't have any

control over how much money that was your.

Plopping a mountain and you'd happy that you got it.

But obviously when you are the you're the person who owns this business.

You get to decide how much you save in your account.

And that's where the nuance of one is better is exists because

they have different contribution limits, different ways stacking up.

And so the employer contribution limit is limited at 25% of your.

Adjusted compensation.

And so you are not profitable as a business you might not be able to

save as much that employer component.

So if your profits are really, really small, 25% of really small

amount is obviously even smaller.

Versus you're super profitable, 25.

It's maybe really massive and they have an upper cap that's

just over $60,000 as the maximum.

So obviously if you're a really profitable, you'd get on that upper.

cap.

the coolest thing about a solo 401k or any 401k, is that in addition

to that employer contribution, there's an employee contribution.

Now you're the person, but when you're wearing your employee hat, you sneak a

few more dollars in and that's the really cool And so those extra dollars that

you sneak in aren't limited by the cap.

So even business that wasn't turning a profit could save

the employee contribution.

If you've got that wages.

you can sneak it in.

And so it ends up being just better.

So even businesses that don't make a bunch, they're not worried

about 60,000 cap you can still get more money in into that solo 401k.

okay.

Wow.

There was just a lot there you said between employer,

employee and minimums maximums.

So let's break it down a little bit.

You said that, and this is why there's so many questions out there around

which account to use and how to use it.

And it gets confusing because.

As an entrepreneur, you are both employer and the employee.

So first let's talk about the SEP IRA.

Let's go ahead and stick on this contributions, because this

is a big point on the SEP IRA.

Tell me about contributions.

If I'm a solo business owner,

So if you're a solo business owner, you're just limited to

employer contributions only.

There's no employee component and they're limited the smaller amount of, I it's

$61,000 in 22 or 25% of compensation.

So that's the cap.

That's how much you can put in.

get to decide how much you want to.

put.

But that's what you're capped at.

Now, is that 25% compensation, gross revenue, net revenue,

25% of which one is that?

It's this kind of funky, like adjusted income number.

If I remember right.

Where you've taken out some of your self-employment

taxes and things like that.

So it's an adjusted slightly low.

Then maybe the number you have in your head, but it is uh, this

like adjusted income number.

Okay.

So basically an adjusted income number and you can take 25% of

that as employer, SEP IRAs, only employers can contribute no employees.

So we take that a whatever the business made as employer and as the owner

of that business, we can decide, up to 25% of that could get in.

So if we made about a hundred thousand in our business, we could contribute

about 25,000 into the SEP IRA.

And That's our maximum we're limited by that 25%.

Even if you wanted to put more in.

Yeah, exactly.

Yup.

Yeah.

Yeah.

Correct.

Okay.

And then if you made or 300,000 were also kept by the IRS cap,

So that's the upper limit um, for any of these employer retirement

plans.

So now that let's compare that contribution to the solo 401k.

You said that both the employer and the employee can contribute to that.

that's right.

And so you the normal 401k contribution limit for employees as well, which

at this point just over 20,000.

And then also, if you're over 55, can get the catch-up which is an even more

amount that the employee gets to put in.

So you've got this big pile of money that you're just allowed as a dollar amount.

not a percentage of, it's just a dollar amount that you're

allowed to defer your wages.

okay.

All Right.

as the employee, I have wages that I'm paying myself out of the business and

I can put up to about 20,000 or even 26,000, you know, that, from that side.

And I can contribute 25%.

As the employer, I can contribute 25%.

So we have an example say making a bounce.

So you're still kept though at that 61, the 61 includes the contributions.

So you unfortunately can't get over that So if you already managed to get up to

the 61, it's a cap that's like the total amount that can be put into the plan.

gotcha.

And then the

let me just run through some numbers

that

And the catch-up sits on, top the 61.

61.

Yeah.

Okay.

All right.

See, this is why the listeners are confused.

Yeah, they don't try to make it easy.

So if you're really adverse all of the, navigating the waters, it

once, figure out what supposed to do with the plan that picked and

then just do that every single time.

Yeah.

Okay.

But I do want to move on to get some details on the SEP IRA and how, and

what are some other fundamentals there, but just to cap this terms

of contribution, cause this is.

of The number one question.

For self-employed business owners because they want to contribute,

maybe a lot of money these deferred plans or a tax-free Roth plans.

So let's just, let's put a a pin in one.

If you have 82,000 of income for your business, okay.

on the SEP IRA, 25% of that, it's about 20,500 that you

could get into the SEP IRA.

Okay.

you can put in as the employer Yup.

What'd you put in As the employer.

that's right.

Okay.

If you had a solo 401k, you could do that same 25% that

plus as the employer are good.

And plus the employee, another to 20,500.

So 41,000 total.

So out of your 82,000, You can put 41,000.

Yeah.

You got double.

All Right, So there you go.

So that's why, , it really depends on that the business income level, and

also how much you want to put away.

Maybe you don't want to put away, know, that much, but there's the

bottom line again on contributions.

Why the solo 401k, oftentimes really outweighs one of the

reasons it might outweigh

You can save more in more circumstances because of that

employee contribution limit it.

There you go.

All right.

I love the way you said that you could save more in more circumstances

because of that employee contribution.

Perfect.

All right.

So let's go back to the SEP IRA and talk about a few more of the details.

What exactly, if the listener is interested in that SEP IRA what are some

of the other details about how those work.

So a set by rate is a little bit a unique as far as retirement

account types that are sponsored by employer because you get to open

it at whatever custodian you want.

You're not as limited SEP IRAs are just very plentiful.

There's the, every custodian seems to offer one you can

open one basically anywhere.

And then you just have full access it the way you would.

People forget.

Sometimes it's not a a traditional IRA because it just so much

behaves like traditional IRA in how you're trading in the account,

how you're investing the funds.

There's not as much Overhead as a 401k has to have.

And you just have a lot of flexibility in what want to buy.

And now as the employer, you get to set up the document, regardless of , which

type of account you want to set up.

So you always have a lot control over exactly how this plan works, but

SEP IRA is just very, it's designed be simple for people it's designed

to have a simple fide plan com.

And so there's all of that And then also you're allowed

to roll out money from a SEP.

You can just roll it over your traditional IRA, whereas in a 401k, sometimes you

might end up with a plan document that let you roll it out until you're done with

the business you're over a particular age.

And now, again, you're the employer you get to pick what's in the plan document,

but a lot of times for solo 401k is.

You of get this pre-packaged plan.

This is what E-Trade one looks like and there isn't customization it.

So while you can shop between custodians find the features that

you want you might, if you're one, a particular custodian, you might get

stuck with their cookie cutter and it not be quite what you want it to be.

Whereas with a SEP IRA it's already really easily accessible.

And yeah, it just has that simplification of use.

So does that mean Megan?

If I have my own business and I'm about doing the SEP IRA for this reason, maybe

others, can I just go any custodian and open an account and just click on like,

I'd like open a SEP IRA and click through, it's kind of that simple in a sense.

in a sense, normally there's a plan document at point that you have to sign.

And if there isn't it's because you've already created.

And you're providing it them.

But normally there's a plan document at some point that you have to say

that like I'm establishing a SEP.

that's an kind of form.

They, it, doesn't always, it's not always like on IRS letterhead,

but it's an IRS required document.

Yeah.

Okay.

Yeah.

So it has that extra step that a traditional IRA

wouldn't have had that step.

But it's very simple.

Whereas a 401k, if you have over a certain amount of money, you

get some IRS filing requirements

. then also you have a lot accounting

You'll just have to save that says how much money you put into it.

And things that.

So there's a little bit more paperwork, both in the initial setup and then

in the maintenance of the plan.

So you, if you're really hate paperwork, a 401k, will give you

more paperwork, but again, you might be able to twice the amount a SEP.

So you'll have to weigh the, your dislike of paperwork versus the really wonderful

options that you get in the 401k.

got you.

Okay.

So the SEP IRA is simpler, straightforward to set up and less

little bit less ongoing requirements.

But again, the downside is, your contribution limits, especially

as your business has grown.

And, contributions you might want to do more in the future that, you

gotta weigh the pros and there.

Now you also mentioned you can roll the money out of the SEP

IRA into your traditional IRA.

If you want it to do that, what would be the benefit or why would

you want to roll that out your IRA

Yeah, you could roll it out.

For example, instead of just going to a traditional IRA,

you could convert it to a Roth.

And so it's a sneaky way that you can turn it into ROTH funding cause you put it in,

you get your deduction for putting it into the SEP and then you convert it to Roth.

It turns into something like a backdoor scenario because it's got deduction

paired with the taxable Roth conversion of canceling one another out on your own.

okay.

Interesting.

you can take your SEP IRA contribution.

You can roll it out into rollover, traditional and then you can

convert that into a Roth IRA.

Or you could

just roll

a

way

Or could just guide you.

You don't even to go to, you can just roll it from the SEP

IRA straight into the Roth IRA.

Yeah.

Yep.

And at that point, it won't the funds won't be in an employer plan anymore.

They'll be out of it your Roth IRA.

So it's not an in plan Roth conversion.

It's rolling it out of an employer plan into a Roth IRA.

I only specify that because in a

me Megan.

you do an implant conversion and it's a different thing.

So

And this is a big difference.

Actually.

Let's pause on for a minute, because this is a big right?

Megan, this is why, when you do a Roth conversion, when you transfer

money from a traditional rollover or SEP IRA, they're all counted.

in terms of the conversion.

for the AI that's right For the basis.

when you do conversion.

So if you have, so don't don't misunderstand your, if have say a couple

of hundred thousand in an, in a rollover IRA already, and now you've got your

own business and you're setting up a SEP IRA and you contribute 20,000 it.

If you convert that 20,000 straight to a Roth you've got to combine that with that

200,000, you already have a traditional IRA in terms of tax consequences.

For determining portion of your non-deductible basis, that is used up.

So luckily you don't have to a total conversion of both in order to do

one of them, but if you're a backdoor or nondeductible contributions to

a traditional IRA, having a SEP IRA balance will mess up a back door.

Suddenly you put 6,000 in and trying to convert it to have all 6,000 not be taxed.

Basically because of the basis, but then you got the set by era, it

actually is only the smaller percentage.

That's not taxable.

And the rest of it is getting taxed on the conversion anyways, whereas a

401k, it doesn't count as part of that asset pool that is considered basis.

And so by contributing to that 401k, you can leave effectively

your traditional IRA balance.

Okay.

Waiting for your clean backdoor to come through?

That the clean bag door, it's got a whole nother level a picture in my mind.

Now have a nice clean back door that can do.

I usually say without any tax consequences.

So yeah.

that's exactly right.

So I just wanted to highlight that for the listeners.

SEP IRAs, traditional IRAs, rollover, IRAs are all combined when you're

talking about conversion to Roth.

So keep that mind if you've been doing them in the past, or you want to do

them in future, that if you add a SEP IRA you gotta keep that in mind.

Now, if fully convert yourself every year, then you're also doing

non-deductible contributions and fully converting those, it won't mess anything

up because you'll end the year with a zero balance in all of your accounts.

It's only if you're ending the year with a balance in that traditional

that some of the non-deductible basis is going to stay behind.

Yup.

Yup.

Or if you already, you know, I run across this or if you already have a large

balance, in your traditional a rollover.

Okay.

And so don't think, oh, I can start a new SEP IRA.

And they said, we convert this , and this is why another reason for.

the 401k.

All Right,

So let's talk about that.

And you know, the that's, what's nice about the separation, right.

401ks have their own rules when it comes to, in plan conversion.

So tell me a little bit more about let's switch over to the 401k is on

this topic, getting into Roth dollars.

What can we do there for self-employed?

We want to set up our own 401k.

So when a whether it's a solo 401k, or it's just a

401k, can have a Roth component.

You decide in plan document, are your employees allowed

to put money in on a Roth?

side And you'll get to make that choice.

Some customers.

I don't have a Roth option, so you can shop around for one that does have it.

But in their like standard document, but as the employer will get to pick

that So if you choose, yeah, of course, they want to money in a Roth then your

employee contribution gets to go in.

Roth instead of going in as a deferral and it will grow Roth it will be

its own little piece of the pie.

And that piece of the pie will the Roth piece of pie.

And so that's really great.

super valuable.

It doesn't even require a conversion or anything to do it.

it's not.

Limited in the same way that a Roth IRA, if you, all, you made too

much, can't put it in the rough IRA.

Well, 401k's, don't have that problem.

So you can always put it in as Roth.

So even if you make way too much to walk in the front door of a Roth, can

walk in the front door of a Roth 401k.

That just makes it super valuable and helpful.

Some plans also as a separate piece will permit what's called

in plan Roth, conversions.

And that means that some of the traditional balances, like that

employer contributions that you put in there and you weren't able to

save and Roth, you can those within the 401k plan to a Roth account.

That's a little bit rare for solo 401k to have in the document, but

is definitely something that 401k plans can do and that some custodians

may have in their cookie cutter.

So it is something that you can ask about you're trying to figure

out where you want to open it, because it's definitely possible.

And there's tons of 401ks that have it.

But that will let then keep your black door all nice and clean and tidy

while still doing Roth conversions of all of that employer contributions.

So you can get a lot of rough money going when you've got that 401k option.

So Yeah.

this is fantastic.

And it gets, know, this is why it gets so messy and know, for entrepreneurs

to figure this out because you got maybe a partner and they've got

accounts and you've got some old accounts and how do you contribute?

What are the limits?

And what's tax consequences.

So there's definitely stuff to figure out here, but I love what you said, the 401k.

You can have the Roth, if it's in your plan document, you have a Roth

and you get around those income limits, get around quote unquote,

There's no income So you just walk right in.

right.

Yep.

Yeah, that's right.

know, In the raw, so you can contribute to Roth dollars and we love that

tax-free forever, Megan and I are big fans of the Roth of everything.

Tax-free forever.

then you also mentioned some plans and again, plan documents you got to

shop for which custodians allow you to do, which types of things with your

plan document It's very important, but you could do in plan conversions.

So you as the employee.

I can go ahead and put your contributions straight the

Roth, 401k, if that's an option.

And then if you have the ability to do in conversions, those employer dollars

from that 25% of profit sharing, or, revenue could also be converted

over to that Roth side of the 401k.

Yep.

That's right.

Yeah.

And so you can get lots and lots of Roth money going.

yeah.

I've got a couple of questions for you.

One.

Have you run across solo 401ks that allow after tax employee contributions.

I have not

explicitly

Run across them, but I think that it make as much sense a solo 401k because normally

those after tax contributions are when your bum employer won't put more money

in you want to save more money there.

You can be like, look, he didn't even up the 61 and you get put

more money in at that point.

And that's why it's that after tax you've got, you've earned it

then you're filling up the bucket.

But when you're in the employer, it's a little harder to end up in a

situation where like that bum employer won't fill up my won't up my 401k.

you may, as you may as well, just fill it up all the way, because you're the

employer and then you can get it in pre.

But it's true that if

you've

got

that, limit,

Yeah.

The limit.

limit

Now I think that were the 401k, I don't know if they call it an contribution,

but your employer is allowed to

, put more money in than that.

They just don't get a deduction for it.

So it's like effectively after tax.

I don't know if still call it that when the employer's the one who's

doing it, because it's not like.

On the employee's return.

And then it's going back in it's on the employer's return.

Um, Now when you're both hats, it really even matter?

I don't know, but I don't know they'd still technically call that, but when

401k you're allowed to put, technically you're allowed to put more than 25% in up

to that 61, but the extra that you put in isn't deductible as a business expense.

Interested.

All right.

I gotta dive more into that,

my understanding, least it effectively results in it being after

techs on your own return, on your business, as opposed to after tax on your

own return as wages, which is what would have happened for an who did after tax.

Yup.

Most businesses don't

get that in,

do that when they have like a of employees, because, suddenly you've

just have all this money that you don't get a deduction for that paying tax on.

So most businesses do it, which is why it's normally the employee who's doing it.

But as a solo, go for it.

So I'm going to, I'm going to put a pin in one because I definitely

want to research a little bit more get that out there on how that might work.

Cause it's pretty interesting because of course, if your business

is making, 150,000, you 25%, isn't going to the 61,000, even

with the employee contribution.

So it would be great, right?

To how do we get that 61,000 in there, if there are are a couple options.

After tax contributions from the employee or nondeductible contributions

from the employer strategies for doing that, might make sense for

a lot of entrepreneurs out there.

Yeah, let me see if I can articulate one more time.

Really accurately, which is, I think that it's that 401k plan

employer are limited to it's either $61,000 or a hundred percent that

particular participants compensated.

And then you are only allowed a deduction up 25% of all participants,

which if it's only you, then it's you compensation plus the amount of any

elective deferrals the employees made.

So you're always allowed to that elective deferral and get the

deduction, but you're not allowed to do.

More than 25% of again, if it's only you, your compensation to get

the but you can put up to a hundred percent of your compensation but

you're limited by that 61 cap.

So

okay.

That's the accurate, complex way of saying it.

Succinctly as possible.

And I know that it's on your article, which of course we'll link to in

The show notes, which is great.

It has a lot of details in there as well.

So you can read all about that and do more research.

I contact Megan, if have more questions.

But I did want to mention something else too, which was, and I've

run across this a lot, Megan.

What about rolling money up into to get that clean.

back door, right?

Rolling your current traditional IRA money, maybe a hundred thousand dollars

you took out of some previous job.

And it's in rollover IRA into your solo plan.

Do you see that as part of the plan documents often, or you

can definitely do that, to have roll ins into your solo 401k.

I don't know that I've looked closely at the documents that I have for

particular feature, most of the time.

People are trying to convert it more than they're trying to reverse rollover it

with the people that we're working with.

But I know that it's definitely possible 401ks.

So it would, it's conceivable that a solo 401k cookie cutter could

have that rule in the air because.

You're allowed to do it in a a plan document.

And that's definitely a super valuable tool to have in your tool belt, because

even if you already have a nondeductible basis in your traditional right now,

and you're like, oh, I can't get to it because I have all these funds in IRAs

and I can't seem to get it into my rock.

You can actually do a reverse rollover of everything except for

that basis into your 401k plan.

And you're not allowed to put that basis into your 401k basically.

So you leave it behind and suddenly you have beautiful centrifuge that has just

perfectly separated your non-deductible basis from the pre-tax, traditional basis.

And you just do a completely clean backdoor all of that.

And then you could even roll it back out and have your traditional IRA again.

So it's a really weird situation, but but can result in a clean door.

You can tidy it up enough that you can get that basis out.

So long you're not paperwork adverse, cause there's a lot of paperwork

involved in that, moving it into the plan normally takes a little bit

of doing, moving it out of the plan sometimes takes a little bit of doing.

As long as you're not adverse to the paperwork, you can get

all of that nondeductible basis out of there and into a Roth.

Again, you need to have the 401k to do it.

But here's a, here's an for some entrepreneurs.

Maybe they just have a little side.

That they're not making a ton of money on, you could still open a solo 401k that.

I'm making about 10,000 a year and the side hustle I have a

schedule C on my tax forms.

You know, It is own business and you could open a 401k.

You could roll in.

That traditional, separate the non-deductible basis , you know?

and then you're now you've got the clean back door from there.

And so there's another opportunity for getting tax-free money a really great way.

Yeah.

I haven't able to out if you even need to be profitable to open a 401k.

I feel like you could just open Cause you're like.

I, I need one of these and I have a business intentions, but I

haven't been able find definitively whether or not you can do that.

Check with your CPA on that.

and I are not going to answer that question.

no.

I that, but it's tools, you know, and that's what we're

talking about is opportunities.

that makes sense, given your situation.

And there's another one that I love.

All right, so let's wrap this up.

What are the difference, between the SEP IRA, the 401k really given the listeners

a lot of different ideas to think about.

What's again, the bottom line, what are the differences that matter in terms

of the SEP IRA versus the solo 401k?

think we've, hit really hard on the streets the solo 401k.

So hopefully by this point everybody who's listening is convinced.

You can save more money, you do more things.

more planning opportunities.

You probably deserve a 401k.

That being said, know, right now, It's just recently the

new year people in tax season.

They're trying to file their taxes.

Maybe you've had a business last year and it made a bunch of money and

you're of listening to this man, I regret not having a retirement plan.

I'm just missing out so much opportunity.

cool about A SEP is that you can open it anytime before you file your tax return.

That includes if you file for an extension on your tax return.

So you a lot of time to open a separate.

You could just open one today and you could put money in for last year.

can do a prior year contribution to it.

And that is really cool.

And that's something that you can do with SEP that you can't do with a 401k.

So even though we hit really hard that you deserve a 401k and

you should look into opening.

If you don't have a retirement plan right now, open us up so that you

can get money in it for last year.

And then later you can figure out how to open the solo 401k.

And you want to that, but just getting some money into a SEP, each new tax

year, you have a limited amount of money you can put into a retirement plan.

And so anytime you can do prior year contributions, To fill up last year's

limit instead this year's limit, you probably should consider doing it just

because it's expiring that opportunity to save that money is going away.

So that's

love that.

first step.

That great.

Really good advice.

Yeah.

Especially here in glad we're doing this the start of the year.

So listeners that are just totally bummed out can say, oh my gosh, did earn money

last year and I want to get that in.

And I love the way you phrase it It's a limited time, each year, you

just had that limited time, but you still have the first quarter or even

extensions, contributing for last year.

So you can get in that time machine and make contributions for last year.

So now's a great opportunity.

For doing that.

Thank you so much, Megan, for all the insights into the 401ks opportunities,

the planning opportunities that entrepreneurs have when comes

to setting up SEP IRA, solo, is, and really appreciate everything.

Yay.

Thanks.

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