Sole Proprietor Plan Types: Owner only 401k or Solo 401k vs. SEP and SIMPLE

A sole proprietorship is the simplest business type—and unincorporated business entity owned by one person. While sole proprietorships can have employees, the majority of entities are owner-only business. The simplicity of a sole proprietorship’s business structure calls for a retirement plan that is specific to sole proprietor or has its best interest. Sole proprietors generally require a retirement plan that is cost-effective for a small business, easy to administer, and beneficial from an income tax perspective.

Sole proprietors typically open one of the following types of retirement plans. Each plan type offers a different approach to retirement plans saving.

Simplified Employer Pension (SEP IRA)

SEP IRA plans allow sole proprietors to shield a substantial portion of employer income from taxes each year (25% of compensation). The contributions are also discretionary, which means you don’t have to make a contribution every year. One of the main differences between a SEP plan and a profit sharing plans is that SEP contributions are made to the sole proprietor’s Traditional IRA rather than to a plan account.  

Saving Incentive Match Plan for Employers (SIMPLE IRA)

SIMPLE IRA plans are also effective and simple to administer retirement options for sole proprietors. SIMPLE IRA plans allow the sole proprietor reduce his or her taxable business income by allowing for the deferral of income on top of a required match contribution.

Solo 401k or Individual 401k or Individual K or Solo K
A sole proprietor with no employees (other than his spouse) also has the option of establishing an owner only 401k plan also known as a Solo 401k or Self-Directed 401k. While owner-only 401k or Solo 401k plans have been available since the inception of the 401k plan, there had been no persuasive tax reason for an owner-only business to establish such a plan. Reason being, other plan types offered the same or larger tax benefit or savings limits, without the added complications. This all changed, however, with passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which changed the way deferrals are included in determining the employer’s deductible contribution. This change resulted in higher contribution amounts in a cost-effective, less complex plan. Also known as Solo k or self-employed 401k or Single K, Solo 401k plans have gained popularity since EGTRRA provisions became effective in 2002.