What Is The Difference Between A SEP IRA And A Solo 401K (QRP)

Corporate tax season is almost upon us and we get this question every day. “I’m self-employed, but I don’t know which one to do between the SEP IRA and the solo 401k?

First, the SEP IRA is one of the most popular employer plans that self-employed individuals can set up, especially when self-directing their accounts. It’s an employer pension plan that allows you as the employer to make large contributions that exceed what you can in your personal plans, like a traditional or Roth.

The SEP IRA allows you to make tax deductible contributions upwards of $57,000 for 2020.  For 2021, if you want to make contributions for current year, it’s $58,000.  It’s based on your income, so check with your CPA or your financial planners.

Typically, the contribution is currently the lesser of those numbers (57,000 or 58,000), or 20% of your income or 25% of your income if you’re W2 waging yourself.

Things to Keep in Mind

SEP IRAs are popular with small business owners who might be family run. One thing to consider with the SEP IRA is that for the percentage contribution you make for yourself, you must also make the same percentage for all your employees. For instance, if you make 100K as a self-employed individual, and want to make a 10% contribution to your SEP IRA ($10,000), you must also make a 10% contribution to each employee fitting the qualifying criteria of your plan.

Who qualifies for your plan, you ask?

This is dictated by you on the SEP 5305. You can dictate at what age or how long someone has to work at your company to qualify for the SEP employer pension plan.  Remember, the contributions are from you (the employer), and you must make equal contributions percentage-wise, based on their income as you do with your own.

SEP IRAs can be converted to Roth IRAs

Most business owners forget that SEP IRAs can also be converted to Roth IRAs. As a qualified employer, you can convert those contributions over to a Roth IRA, so that your investments grow tax free and penalty free.

Many NuView clients use their SEP IRAs to make large contributions because they’re self-employed and they have the income to do so, then convert those contributions over to their Roth IRA.

And that’s a way to get more than the $6,000 contribution limit that you normally have with a Roth IRA. So, if you want to massively fund a Roth IRA and you’re self-employed, consider making a large contribution to your SEP, and then converting it to your Roth. Then, self-direct that Roth IRA into alternative assets that can grow completely tax-free and penalty-free.

The Solo 401k (QRP)

Now, the solo 401k (qualified retirement plan) works a little differently than any of the IRAs – especially the SEP IRA.

For one, you have two buckets that you can make contributions to:

  1. Your profit-sharing side or plan that you can make contributions to
  2. And you also get contribute as the employee as well to your salary deferral.

What that means is as a self-employed individual, you wear both hats: the owner and the employee.

This means you can make contributions to both.

As the employee, you can make salary deferral contributions, and those contributions can be Roth.

Dependent on your age, you can contribute up to $26,000, and it can be dollar for dollar for the first $26,000 I make. Then, when you want to exceed that, you can make contributions to the other side as well. So contributions can get much higher in a solo 401k than any other plan. However, consult with your CPA as to how much you can contribute.

You Have Checkbook Control

Another great benefit to the solo 401k or QRP is that you, as the owner, account holder and investor have checkbook control. You write the checks for your 401k’s investments. Now that could be good or bad.

Remember with a solo 401k, you are more in control with this type of account. You are administrator at that point. You have to do the government reporting. You might want a bookkeeper for that, but you also write the checks. You have the flexibility to write the checks for your 401k’s investments. It can be a benefit for some, not a benefit for others. That is one of the differences with the 401k that you don’t get with the SEP is the checkbook control.

You Can Take Out Loans to Yourself

Another advantage the 401k offers that the SEP doesn’t is you have the option to take loans out to yourself.

This is something all 401ks allow you to do.

Currently, you are allowed to take loans against your 401k upwards of 50% of the value of the 401k, not to exceed $50,000.

This is good if you have an emergency like medical bills that pop up, or you just have to pay for something personal. Instead of having to take a distribution from your SEP IRA, if you have a 401k, you can just make a loan to yourself. Afterward, you can repay your 401k with interest over time.

No Unrelated Debt-Financed Income Tax

When you buy real estate within a 401k, and you get a loan from a bank to help buy that real estate, there’s this tax called unrelated debt-financed income tax.

That’s normally a problem that you have to face when you invest in debt, leverage property in a SEP IRA, Roth IRA, or traditional IRA. However, in a solo 401k or QRP, there’s a built-in exemption that allows you to not pay that tax. If you’re an investor looking to buy debt, leverage property, or own real estate in your 401k, and that real estate has loans against it, you don’t have to pay unrelated debt-financed income tax.


A couple considerations that you want to keep in mind when opening a solo 401k is that you cannot have common law employees – keep that in mind.

You can have your spouse also contribute to the solo 401k, which gives you more options to make larger contributions for both yourself and your spouse, which essentially gives you more buying power.

The last thing to note is back to that Roth conversion opportunity with the solo 401k. Remember that your employer pension side can also be converted back to your Roth side.

So, you have the option to make large contributions – both salary deferral and pension – but you can also convert the pension side over to your salary deferral, thus giving you more Roth money to work with. And who doesn’t like investing in a completely tax-free manner? That’s something that we like to talk a lot about here at NuView Trust Company.

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