What is the difference between IRS solo 401(k) limits and SEP IRA contribution limits?
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The primary difference between the IRS solo 401(k) and SEP IRA contribution limits for 2025 lies in how contributions are calculated and the maximum amounts that can be contributed, especially for self-employed individuals and sole proprietors.
1. SEP IRA Contribution Limits
- Maximum Contribution: For 2025, the SEP IRA contribution limit is the lesser of $70,000 or 25% of the participant’s compensation (for employees) or, for self-employed individuals, 20% of net earnings from self-employment (after deducting the self-employment tax and the SEP contribution itself).
- Calculation for Self-Employed: The 25% limit is not applied directly to net profit. Instead, self-employed individuals must use a reduced rate (effectively 20%) because the contribution itself reduces the compensation on which the limit is based. The IRS provides a worksheet for this calculation.
- No Employee Deferral: SEP IRAs do not allow for employee elective deferrals. All contributions are considered employer contributions.
- No Catch-Up Contributions: SEP IRAs do not allow for catch-up contributions for those age 50 or older.
2. Solo 401(k) Contribution Limits
- Maximum Contribution: For 2025, the total contribution limit for a solo 401(k) is also $70,000, but this can be increased by $7,500 in catch-up contributions for those age 50 or older, for a total of $77,500.
- Two Types of Contributions:
- Employee Elective Deferral: Up to $23,500 (or $31,000 if age 50+) can be contributed as an employee elective deferral, limited by net earnings from self-employment.
- Employer Contribution: Up to 25% of compensation (or 20% of net earnings from self-employment for sole proprietors/partners), up to the overall $70,000 limit.
- Combined Limit: The sum of employee and employer contributions cannot exceed $70,000 (or $77,500 with catch-up).
- Catch-Up Contributions: Solo 401(k)s allow for an additional $7,500 catch-up contribution for those age 50 or older.
- Roth Option: Solo 401(k)s can allow for Roth (after-tax) employee deferrals, which SEP IRAs can now also allow under recent law, but the mechanics differ.
3. Key Differences
- Employee Deferral: Solo 401(k)s allow for an employee deferral component, which is not subject to the 25% of compensation limit. This means that even with lower net earnings, a participant can contribute more to a solo 401(k) than to a SEP IRA.
- Higher Contributions at Lower Income: Because of the employee deferral, a solo 401(k) allows higher total contributions at lower levels of compensation compared to a SEP IRA, which is limited strictly to a percentage of compensation.
- Catch-Up Contributions: Only solo 401(k)s allow for catch-up contributions for those age 50 or older.
- Loan Feature: Solo 401(k)s may allow loans; SEP IRAs do not.
- Administrative Complexity: Solo 401(k)s require more paperwork and, if plan assets exceed $250,000, require filing Form 5500-EZ. SEP IRAs are simpler to establish and maintain.
4. Example
Suppose a sole proprietor under age 50 has $100,000 in net self-employment income (after deducting half of self-employment tax):
- SEP IRA: The maximum contribution is about $18,587 (using the 20% effective rate).
- Solo 401(k): The individual can contribute $23,500 as an employee deferral plus $18,587 as an employer contribution, for a total of $42,087 (subject to the overall $70,000 limit).
5. Statutory Authority
- SEP IRA: IRC § 408(k), with annual limits set by IRC § 415(c) and adjusted for inflation.
- Solo 401(k): IRC § 401(k) and § 415(c), with employee deferral limits under IRC § 402(g) and catch-up contributions under IRC § 414(v).
6. Summary Table
*Roth SEP IRAs are now permitted, but implementation may vary by provider.
7. Conclusion
Solo 401(k)s generally allow for higher contributions at lower income levels due to the employee deferral feature and offer additional features such as catch-up contributions and loans. SEP IRAs are simpler to administer but are limited to employer contributions based on a percentage of compensation.
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