Do you contribute multiple retirement plans? As a self-employed person, you’ve probably heard of a SEP IRA. When you are looking for ways to maximize your retirement contributions and minimize taxes, you might be wondering if you can contribute to both a SEP IRA and Solo 401k at the same time. A SEP IRA is a “Simplified Employee Pension Plan.” A SEP IRA is set up and contributed to by an employer for the benefit of employees. A business of any size, including self-employed, can establish a SEP IRA.
You might already have a Solo 401k or a SEP IRA. Therefore, you might ask the following question. “Can I open and contribute to both the SEP IRA and Solo 401k at the same time?”
The Answer is YES – But How Much Depends…
You’ll find the basic answer that you can have both a Solo 401k and a SEP IRA in IRS Publication 560 on page 6 of chapter 2, under the subtitle “More than one plan.”
“If you contribute to a defined contribution plan (defined in chapter 4), annual additions to an account are limited to the lesser of $57,000 or 100% of the participant’s compensation. When you figure this limit, you must add your contributions to all defined contribution plans maintained by you. Because a SEP is considered a defined contribution plan for this limit, your contributions to a SEP must be added to your contributions to other defined contribution plans you maintain.”
Added for emphasis, the underlining of “your contributions” (employee) in the IRS quotation.
In other words, any employee contributions an employer makes for your SEP IRA and contributions you make as employee to your own Solo 401k must be aggregated. When you contribute to both a SEP IRA and Solo 401k at the same time, there’s a limit how much you can contribute. Don’t go above your total employee maximum contribution ($19,500) across all plans. You cannot “double dip” employee contributions across both the SEP IRA and Solo 401k at the same time.
Contribute to Both a SEP IRA and Solo 401k
Importantly, if your SEP IRA and Solo 401k are both connected to the same business, then the contribution limits max out across both plans at $58,000 per participant. The contribution limit increases to $64,500 if you are age 50 or older and able to make catch-up contributions. The key here is that a Solo 401k has two types of contributions: Employee and Employer contributions. However, SEP IRAs only allow for employer contributions. If the sponsoring employer for both the SEP IRA and Solo 401k plans is your business, the $58,000 limit applies across both plans
However, if your SEP IRA and Solo 401k are connected to different businesses, the rules change. Therefore, you can maximize even greater contributions. Always check with your CPA to see if controlled group rules apply and may limit your contributions.
If you have a SEP IRA through one employer and a Solo 401k through your own separate small business, calculate each contribution separately. The maximum employer contribution is per plan. This is because one employer cannot be expected to know how much another employer will contribute.
However, your employee contribution is accumulative across all plans. You are the “common denominator” of being an employee at various businesses.
Maximum Contributions Across SEP IRA and Solo 401k
Because employees do not make personal contributions to a SEP IRA, you can make the maximum employee contribution to your Solo 401k. The maximum employer contribution can also be made to both the SEP IRA and the Solo 401k. That’s because the maximum is per employer plan.
Keep in mind that 50 catch up contributions do not apply to the employer portion of either plan.
For 2021, you can make a maximum Solo 401k employee contribution up to $19,500. That number increases to $26,000 if you are age 50 or older. The maximum employer Solo 401k contribution can be $38,500 for a total of $58,000. The all-inclusive total can be $64,500 per year if you are age 50 or older.
As long as your SEP IRA contributions are from a different employer, the maximum employer contribution to the SEP IRA can also be $58,000.
A Solo 401k PLUS a SEP IRA total tax-deferred contribution could be as high as $116,000 or $ 122,500 if you are age 50 or older.
However, there are some percentages of earnings calculations that go into the overall equation…
A Deeper Look at the Limitations and Requirements
To qualify for a SEP IRA, you must meet the following:
- Be at least 21 years old,
- Have worked at the business for three of the past five years, and
- Have earned at least $600 from the job in the past year.
Your SEP IRA contribution each year cannot exceed the lesser of 25% of your compensation or $58,000 for 2021. The maximum amount of self-employment compensation that applies for 2021 is $285,000. For self-employed individuals, the amount of compensation used for these purposes is your net earnings from self-employment less the deductible portion of self-employment tax, and the amount of your own retirement plan contribution deducted on form 1040.
SEP IRA benefits include the high deduction limits, high income through tax-deferred growth, and flexibility in contribution limits. The allowable SEP IRA contribution is substantially higher than a traditional IRA limit of $6,000 for 2021.
For a Solo 401k plan, the 2021 limit is $19,500, plus a $6,500 catch-up contribution for those individuals over age 50. That contribution amount is up to 100% of your compensation. The employer profit-sharing contribution does not count toward this limit. However, the total contribution limit of both the employer and employee in 2021 is $58,000. If you are age 50 or older, the limit is $64,500.
Additional Considerations When Maximizing Your Retirement Contributions
If you find yourself in the fortunate position of considering both the SEP IRA and Solo 401k, you probably also need to become familiar with rules covering highly compensated employees.
You can analyze different scenarios using our Solo 401k Contribution Calculator.
You may also want to read our Contribution FAQs.
Did you contribute to more than one qualified retirement plan during the calendar year? If so, it is your responsibility to ensure that you have not exceeded the allowable limits.
Did you have self-employment income from a side business in addition to W-2 income from employment? If so, consider contributing to a SEP IRA plan or Solo 401k. Doing so will maximize your retirement savings. The safest road to your ideal retirement is to save now. Then, hit your max contribution limits as soon as possible. Staying the course for the long haul grows your nest egg into long-term wealth.