Self Directed 401(k)s Versus Self-Directed SEP IRAs

Which is Better for Small Business Owners?

For many owner-operators of small businesses, the Self-Directed Solo 401K may be the way to go, rather than a self-directed SEP IRA plan. Here’s why:

With a Self-Directed Solo 401K plan, you aren’t limited to only one kind of contribution. 401(k) plans allow you to make substantial annual contributions both as an employee and as your own employer, via profit sharing contributions. The business you own and control can make contributions of up to 25 percent of compensation (20 percent for sole proprietorships or single-member LLCs), resulting in a maximum annual combined contribution of up to $53,000 per year.

If you’re age 50 or older, you can potentially defer even more: You can contribute up to $24,000 per year, including an additional $6,000 per year in “catch-up” contributions – and still have the small business you control contribute up to 25 percent of compensation on top of that, for a maximum combined Self-Directed Solo 401K contribution of $59,000.

With a self-directed SEP IRA, on the other hand, you are limited to just the employer contribution of $53,000 and no possibility of additional catch-up contributions under current law.

Furthermore, the total contribution to a self-directed SEP IRA cannot exceed 25 percent of total compensation. That limitation applies to the entire plan. With a self-directed solo IRA, the 25 percent of earnings cap only applies to the employer match portion of the contributions for the year.

Furthermore, a solo 401(k) offers self-directed retirement plan investors the option of establishing a Roth account. This means that contributions will no longer be pre-tax, but the growth in the account will compound tax free for as long as you leave the money in the account. The Roth 401(k) will generally generate tax-free income in retirement for as long as you like, until your Roth funds are exhausted. There is no required minimum distribution requirement that will force you to begin drawing down your account and paying income taxes after you turn age 70½.


The 401(k) allows for much more flexibility if you want to access your money early.

If you start a Self-Directed Solo 401K plan, you have the option to allow plan loans, which can provide you with a tax-free source of liquidity of up to 50 percent of the 401(k)’s total value for any purpose you like. The catch: You must repay yourself, with interest, within five years of taking out the loan, or your outstanding balance will be subject to income taxes and possible penalties for early withdrawal unless you are at least Age 59½ or otherwise qualify for an exception.

This option is not available for SEP IRAs or any other kind of IRA. While you can lend money to certain third parties within your IRA, you cannot lend money to yourself, your spouse, ascendants or descendants and their spouses.

Tax Efficiency

If you are a self-directed real estate real estate investor or you want to use leverage within your retirement account to invest, you would generally be subject to possible unrelated debt-financed income tax within a self-directed SEP IRA. In most cases, your Self-Directed Solo 401K will not trigger that tax – which can approach 40 percent – provided you use a non-recourse loan.

While there is no one-size fits all situation, if you are a self-employed small business owner and you want to maximize both the amount of money you can contribute each year – especially after turning 50 – and your choices, it may make sense to carefully consider a solo 401(k) plan.

American IRA works with small business owners and self-employed individuals who use precisely these strategies to help them get the most out of their available retirement assets. We’d like to help you do the same.

Call American IRA today at 866-7500-IRA(472), or contact us via the Web at