This is part 2 of The Solo 401(k) mini-series. In Part 1, I discussed why the solo-K is so great and the necessary conditions for opening one.
What about the SEP-IRA?
You may have heard about the SEP-IRA (or just SEP) as another retirement account option for the very small business. The SEP-IRA has the same contribution limits as the solo-K, but contributions are made by the employER only. SEP-IRAs do not allow for Roth contributions. While you can contribute the same amount to a SEP as you can to a solo-K, having a SEP-IRA (since it is a pre-tax IRA) will prevent you from contributing, tax free, to a backdoor Roth IRA.
So, why would you open a SEP-IRA instead of a solo-K? The main reason is that a SEP can be opened after the calendar year for which it applies. You can wait until your tax due date, including extensions (around October 15th), to open and fund a SEP-IRA. For example, you have until 10/15/18 to open and fund a SEP for 2017. (Even if you have already filed your 2016 return and didn’t know this rule, you still have time to amend your return and open a SEP for 2016!) By contrast, you must open a solo-k by the end of the calendar year it is for. A very minor reason to open a SEP over a solo-K is that the paperwork to open a SEP is simpler. But don’t do it just because you’re lazy!
Contributions to either a Solo-K or a SEP are based on net profits adjusted by FICA taxes (Social Security + Medicare taxes). The contributions to a Solo-K and a SEP are the same if you have already made your $18k employee contribution at work. Otherwise, you can add what remains of your employee contribution, up to $18k/$24k to the maximum Solo-K contribution.
Where should I open my solo-K?
There are a few good choices with low to no fee plan options. They differ mainly in:
- Fees: Some are free, some are not
- Traditional vs. Roth employee contributions: Not all will offer the Roth option
- Rollovers: Not all will accept rollovers from old IRAs, 403(b)s, 401(k)s. This is a deal breaker, in my opinion, since the ability to do this is one of the great reasons to have one.
Thankfully, someone else already did a great and thorough review on the most popular solo-K options. Here are my top 3 picks:
- TD Ameritrade: Offers a Roth option. Has a good list of commission-free ETFs including many Vanguard ones. M has his solo-K here and I plan to open one here too.
- E-trade: Offers a Roth option. Lots of free funds.
- Fidelity: No Roth option. Lots of free funds and ETFs.
All of these accept rollovers of old IRAs, 401(k)s. Some offer loans (which I don’t recommend ever doing), too. At this time, I do not recommend opening a solo-K at Vanguard for two main reasons: they do not accept rollovers (deal breaker) and you can only invest in their investor share class funds. These funds have a higher expense ratio than their admiral class fund or ETF equivalents. They also charge a $20 fee per fund in the account annually until you reach a balance of $50K.
Do you have a SEP or a solo-K? Comment below!