Why Choose a Solo 401(k) vs. SIMPLE IRA?

A SIMPLE IRA is similar to a Solo 401(k) plan in that it is funded by employee deferrals and additional employer contributions. However, unlike a Solo 401(k) Plan, a “SIMPLE” plan uses an IRA-type trust to hold contributions for each employee, rather than a single plan trust that is typical of a traditional employer 401(k) plan. It can be opened with a bank, insurance company or other qualified financial institution. But who wins the debate: Solo 401(k) vs. SIMPLE IRA?

Since 2001, the Solo 401(k) plan has overtaken the SIMPLE IRA as the most popular retirement plan for the self-employed or small business with no full-time employees (over 1,000 hours or three consecutive years of 500 hours). This article will examine the reasons why the Solo 401(k) is so much more popular than the SIMPLE IRA, despite its higher administrative burden.

Introduction to Retirement Plans

Retirement plans are an essential component of a small business owner’s financial strategy, providing tax benefits and a means to save for the future. As a small business owner, it’s crucial to understand the various types of retirement plans available, including the 401(k), SIMPLE IRA, and SEP IRA. Each plan has its unique features, contribution limits, and eligibility requirements.

For instance, a 401(k) plan offers higher contribution limits and a range of investment options, while a SIMPLE IRA is easier to administer and suitable for businesses with fewer employees. SEP IRAs, on the other hand, are ideal for self-employed individuals due to their flexibility and high contribution limits. Understanding these differences can help you choose the right retirement plan that aligns with your business needs and financial goals.

SIMPLE IRA

A SIMPLE IRA (Savings Incentive Match PLan for Employees) plan can be established by any employer who has less than 100 employees, who will receive at least $5,000 in compensation from the employer in the proceeding calendar year. The SIMPLE IRA plan has a lower deferral limit than a Solo 401(k) plan. However, unlike a Solo 401(k) plan, the SIMPLE IRA plan uses an IRA-style trust to hold contributions for each employee, rather than a single plan like a 401(k) or other qualified retirement plan.

For example, each employee of a business that adopted a SIMPLE IRA can have their own SIMPLE IRA account, which offers the SIMPLE IRA participant far greater investment options. Employers are required to make a matching contribution or a non-elective contribution to the SIMPLE IRA.

Solo 401(k)

A Solo 401(k) plan is an IRS-approved retirement savings vehicle designed specifically for self-employed individuals or small business owners who have no full-time employees other than themselves, a spouse, or business partners. This plan is also referred to as an Individual 401(k), Self-Employed 401(k), or Owner-Only 401(k). Despite the variety of names, it is not a new type of retirement plan—it is essentially a traditional 401(k) that has been adapted to suit businesses with only one participant.

A Solo 401(k) allows for both employee and employer contributions, enabling business owners to contribute more toward retirement than they typically could with other plans like a SEP IRA or SIMPLE IRA. Contributions can be made on a pretax (traditional) or after-tax (Roth) basis, giving plan participants added flexibility in how they manage current tax liability and future retirement income.

Before the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) took effect in 2002, there wasn’t much incentive for self-employed individuals to adopt a Solo 401(k). Other plans, such as profit-sharing plans or SEP IRAs, offered similar contribution limits without the complexity of a 401(k). However, EGTRRA significantly increased the annual contribution limits and allowed for employee salary deferrals in addition to employer profit-sharing contributions, making the Solo 401(k) a far more powerful retirement planning tool.

Thanks to these changes, Solo 401(k) plans have become popular among self-employed professionals, freelancers, consultants, and small business owners looking to maximize retirement contributions, reduce taxes, and maintain control over investment decisions—all within a cost-effective and administratively efficient structure.

Eligibility Requirements

When choosing the right retirement plan for yourself or your small business, understanding the eligibility rules is key. The Solo 401(k) is best suited for self-employed individuals or small business owners with no full-time employees other than a spouse. It requires earned income from the business, and if you hire a full-time employee (1,000+ hours/year), you may need to convert to a different type of plan.

A SEP IRA is designed for self-employed individuals and businesses of any size, but if you contribute for yourself, you must also contribute for all eligible employees. Employees must be at least 21 years old, have worked for you in 3 of the past 5 years, and have earned at least $750 in compensation in the current year. SEP contributions are employer-funded only.

A SIMPLE IRA is available to businesses with 100 or fewer employees and no other retirement plan. Employees are eligible if they have earned $5,000 in any two prior years and are expected to earn at least $5,000 in the current year. Employers are required to make either matching or non-elective contributions annually.

Retirement Plan Eligibility Comparison

Feature	Solo 401(k)	SEP IRA	SIMPLE IRA
Who Can Set It Up	Self-employed with no full-time employees (other than a spouse)	Any business owner, including sole props and corporations	Employers with 100 or fewer employees, no other retirement plan
Employee Eligibility	Must have earned income from the business	Age 21+, worked 3 of the last 5 years, earned $750+	Earned $5,000 in 2 previous years, expected $5,000 in current year
Full-Time Employees	Not allowed (unless it’s your spouse)	Must include eligible employees if contributions are made for owner	Must offer to all eligible employees
Who Contributes	Employee + employer	Employer only	Employee + employer (required match or non-elective)
Business Types	Sole props, LLCs, S-corps, C-corps	Sole props, partnerships, LLCs, corporations	Any small business that meets the 100-employee limit

Solo 401(k) vs. SIMPLE IRA

There are a number of options that are specific to Solo 401(k) plans that make it a far more attractive retirement option for a self-employed individual than a SIMPLE IRA. A breakdown:

1. Higher Contributions

A Solo 401(k) offers both employee deferral and employer profit-sharing contributions, making it a more robust retirement savings option compared to a SIMPLE IRA, which provides more limited employee deferral opportunities.

Solo 401(k) Contribution Limits for 2025:

• Under Age 50: Participants can contribute up to $23,500 as an employee deferral (pretax or Roth). Additionally, the business can contribute up to 25% of compensation (or 20% for sole proprietors or single-member LLCs) as a profit-sharing contribution, for a combined maximum of $70,000.
• Age 50 and Over: Participants can contribute up to $31,000, which includes the standard deferral plus a $7,500 catch-up. Combined with profit-sharing, the maximum contribution is $77,500.
• Ages 60 to 63: An enhanced catch-up of $11,250 applies, increasing the total contribution limit to $88,750.

SIMPLE IRA Contribution Limits for 2025:

• The employee deferral limit is $16,500, plus a $3,500 catch-up for those age 50 and older.
• Individuals between ages 60 and 63 may contribute an increased catch-up amount of $5,250.
• Employers must either:
  • Match employee contributions dollar-for-dollar up to 3% of compensation, or
  • Contribute 2% of compensation for all eligible employees who earn at least $5,000 during the year.

While both plans offer tax-advantaged retirement savings, the Solo 401(k) allows for significantly higher contribution limits—especially beneficial for high-earning self-employed individuals—compared to the more limited structure of a SIMPLE IRA.

2. After-Tax Roth Accounts

The Roth feature has been a popular option for years for Solo 401(k) plan participants. A couple of years ago, there was no Roth option for SIMPLEs. However, thanks to SECURE 2.0, that’s no longer the case.

If the plan permits, a Solo 401(k) investor can make after-tax Roth contributions to the plan, and enjoy tax-free qualified withdrawals during retirement. So long as you are at least age 59 ½, and the Roth has been open for at least five years, all distributions will be without tax. And this is true for IRAs and 401(k) plans.

One could always convert a SIMPLE IRA to Roth. However, a two-year “hold rule” applied for conversions, imposing a 25% penalty for early conversions. Now, if their plan offers it, participants can direct both their own contributions and employer contributions directly into a new SIMPLE Roth account, bypassing this waiting period entirely.

3. Tax-Free Loan Option

With a 401(k) plan, a plan participant can borrow up to $50,000 or 50% of your account value, whichever is less. The loan can be used for any purpose but must be paid back over a five-year period using a minimum interest rate of Prime. Pay yourself back, with interest, instead of a bank or other lender.

With SIMPLE IRA, the IRA holder is not permitted to borrow even one dollar from the SIMPLE IRA without triggering a prohibited transaction.

4. Use Non-Recourse Leverage and Pay No Tax

With a Solo 401(k) plan, a plan participant can make a real estate investment using a non-recourse loan (a loan not personally guaranteed by the plan participant) without triggering the Unrelated Debt Financed Income (UDFI) rules and the Unrelated Business Taxable Income (UBTI) tax (IRC 514). The highest UBTI tax rate is a staggering 37%.

The exception is only applicable to 401(k) qualified retirement plans and does not apply to IRAs. In other words, using a SIMPLE IRA to make a real estate investment involving non-recourse financing would trigger the UBTI tax if there was greater than $1,000 of net income associated with the loan.

5. Open the Account at Any Local Bank

A Solo 401(k) offers significant flexibility, allowing its bank account to be opened at any standard local bank or trust company. In fact, IRA Financial can open an account for you at Capital One if you so choose.

An IRA which strictly requires a specialized custodian to hold its funds. While a Solo 401(k) provides this freedom in banking, financial institutions remain crucial for establishing the plan’s legal framework, offering guidance on contributions and distributions, and often providing platforms for investment, even if they don’t directly custody the initial bank account.

6. No Need for the Cost of an LLC

The 401(k) plan itself can make investments without the need for an LLC, which, depending on the state of formation, could prove costly. Since a 401(k) plan is a trust, the trustee (on behalf of the trust) can take title to a real estate asset without the need for an LLC.

While an LLC is not required, many self-employed individuals choose to form an LLC for reasons like:

• Liability protection: An LLC separates your personal assets from your business liabilities.
• Tax flexibility: An LLC can elect to be taxed as a sole proprietorship, partnership, S-corporation, or C-corporation, offering different tax advantages depending on your situation.

7. Better Creditor Protection

In general, a Solo 401(k) plan offers greater creditor protection than a SIMPLE IRA. The 2005 Bankruptcy Act generally protects all 401(k) plan assets from creditor attack in a bankruptcy proceeding. In addition, most states offer greater creditor protection to a Solo 401(k) qualified retirement plan than a SIMPLE IRA outside of bankruptcy. Solo 401(k) plans follow the same rules as traditional 401(k) plans in terms of asset and creditor protection.

Investment Options

Both Solo 401(k)s and SIMPLE IRAs offer distinct investment landscapes. A Solo 401(k) provides extensive flexibility, often allowing for a “self-directed” approach. This means you can invest in a broad spectrum of assets beyond traditional stocks, bonds, mutual funds, and ETFs, including alternative investments like real estate, private equity, precious metals, and even cryptocurrencies. The specific options depend on your chosen custodian, with some specializing in allowing these less conventional assets, provided they comply with IRS regulations regarding prohibited transactions. IRA Financial does not place limits on the types of investments you can make!

In contrast, a SIMPLE IRA generally offers a more streamlined and limited selection of investment options. These plans are typically managed by traditional financial institutions that provide a curated menu of mutual funds, ETFs, individual stocks, and bonds. While suitable for those seeking simplicity and a standard diversified portfolio, SIMPLE IRAs typically do not accommodate direct investments in alternative assets like real estate or private businesses. Your investment choices within a SIMPLE IRA will be largely dictated by the specific offerings of the financial provider.

Of course, with the right custodian, you can choose a Self-Directed SIMPLE IRA. IRA Financial does offer this option, as do other providers. Carefully consider your options when deciding. Make sure to check out fees, investment options, and other services.

Administrative Responsibilities and Burden

Notwithstanding the above on the Solo 401(k), the SIMPLE IRA does have a number of attractive advantages for small businesses:

• Available to any small business – generally with 100 or fewer employees
• Easily established by adopting a SIMPLE IRA prototype or an individually designed plan document. In fact, you can establish a Self-Directed SIMPLE IRA quickly and easily with the IRA Financial app.
• No filing requirement for the employer since the IRA custodian would be required to file IRS Form 5498. In the case of a Solo 401(K) plan, if assets are above $250,000 as of December 31 of the previous year, IRS Form 5500-EZ must be filed.
• In addition, one quirky rule with a SIMPLE IRA, is that an employer that adopts a SIMPLE IRA cannot have any other retirement plan at the same time, so keep that in mind.
• SIMPLE IRA assets cannot be rolled into another IRA or 401(k) plan until the SIMPLE IRA has been opened at least two years.

Conclusion

Choosing between a Solo 401(k) and a SIMPLE IRA ultimately hinges on your specific needs as a self-employed individual or small business owner. If maximizing your annual contributions and having extensive control over diverse investments, including alternative assets, are your top priorities, the Solo 401(k) is likely the superior choice, despite its slightly greater administrative requirements.

However, if simplicity, ease of setup, and lower administrative burdens are paramount, particularly when looking to offer a straightforward retirement benefit to a small team of employees, the SIMPLE IRA stands out as an excellent, cost-effective solution. Evaluate your contribution goals, desired investment flexibility, and willingness to manage administrative tasks to determine which plan will best serve your long-term financial security.

Maximize Your Retirement Savings with the Right Plan:

Choosing between a Solo 401(k) and a SIMPLE IRA depends on your business structure and retirement goals. A Solo 401(k) offers higher contribution limits, Roth options, and more investment flexibility, while a SIMPLE IRA is easier to set up with lower administrative costs. Understanding these differences can help you select the plan that best aligns with your financial objectives.

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