Dornick Digest

SEP IRA vs. Solo 401(k): What Self-Employed Business Owners Need to Know

Levi Pettit, CFA, CFP® — Wed, 18 Feb 2026 01:01:47 GMT

If you’re a solo business owner considering a SEP IRA or a Solo 401(k), this post will help explain:

How each account is structured
Key trade-offs between the two
What each option allows and what it doesn’t
How to think about which one fits your situation

The SEP IRA

The SEP IRA is one of the most straightforward retirement accounts available to self-employed individuals and small business owners. There’s no plan document to adopt, no annual IRS filings, and minimal ongoing maintenance. You can open one and fund it up to your tax filing deadline, which gives you significant flexibility if you’re making decisions late in the year.

Contributions are made as the employer only, capped at 25% of net self-employment income up to $72,000 in 2026. One thing to keep in mind: if you have full-time W-2 employees, you’re required to contribute the same percentage of compensation for them that you contribute for yourself.

Where the SEP shines: Simplicity, flexibility on timing, and availability for businesses with employees.

Where it has limits: There’s no employee deferral component, so reaching the $72,000 ceiling requires roughly $288,000 in net self-employment income. At lower income levels, you may not be able to contribute as much as you would with a Solo 401(k). The SEP also has implications for certain tax strategies, which we’ll cover below.

The Solo 401(k)

The Solo 401(k), also called an Individual 401(k), is built exclusively for owner-only businesses. If you have full-time W-2 employees other than a spouse, you’re not eligible.

What distinguishes it is a two-layer contribution structure. You contribute as both the employee and the employer:

Employee deferral: up to $24,500 in 2026
Employer contribution: up to 25% of compensation
Combined max: $72,000 in 2026

Because the employee deferral is a flat dollar amount rather than a percentage of income, the Solo 401(k) can allow higher contributions at lower income levels. At $80,000 in net self-employment income, the employee deferral alone from the Solo 401(k) would be greater than the maximum allowable contribution to a SEP IRA. At higher income levels, the gap narrows and the two accounts become more similar in contributions they allow.

Where the Solo 401(k) shines: Higher contribution potential, Roth options, and compatibility with certain tax strategies.

Where it has limits: More administrative overhead and restricted to owner-only businesses.

The Admin Trade-Off

This is where the two accounts diverge most noticeably in practice.

The SEP IRA requires almost nothing ongoing. Open it, fund it, done. There’s no annual filing requirement and no setup deadline beyond your tax return due date.

The Solo 401(k) requires more. To make employee deferral contributions for a given tax year, the plan must be established by December 31 of that year. Missing that window means losing the employee deferral entirely for that year. Once plan assets exceed $250,000, you’re required to file a Form 5500-EZ with the IRS annually. You’ll also need to adopt a plan document at setup, though most major custodians provide one.

For someone who values simplicity and flexibility, the SEP’s lower maintenance can be a real advantage. For someone willing to manage the admin requirements in exchange for greater contribution flexibility and planning options, the Solo 401(k) can be worth the overhead.

Two Planning Considerations Worth Knowing

The Pro-Rata Rule and Backdoor Roth IRAs

If you’re a high earner doing, or interested in doing, backdoor Roth IRA contributions, the type of retirement account you hold matters. I covered the backdoor Roth in detail in a previous post.

In summary, the IRS applies what’s called the pro-rata rule when you convert IRA dollars to Roth. It treats all of your pre-tax IRA balances (Traditional, SEP, SIMPLE, and rollover) as one combined pool. If you have a large SEP IRA balance, a meaningful portion of any Roth conversion becomes taxable, which can significantly undermine the backdoor Roth strategy.

Pre-tax dollars inside a Solo 401(k) are not included in that calculation. This is a meaningful difference for high earners who want to keep the backdoor Roth on the table. If that strategy is part of your plan, it’s worth discussing with your CPA or financial advisor before defaulting to a SEP IRA.

The Mega Backdoor Roth

Some Solo 401(k) plans allow after-tax contributions beyond the standard employee deferral. If your plan permits it, you may be able to contribute after-tax dollars up to the $72,000 combined limit and then convert those dollars to Roth, either inside the plan or by rolling them to a Roth IRA. This is commonly referred to as the Mega Backdoor Roth.

This strategy isn’t available through a SEP IRA. But it also isn’t available through every Solo 401(k), it depends on whether your plan document allows after-tax contributions and in-plan conversions or in-service distributions. If this is something you’re interested in, it’s a question to ask before you open the account.

Side by Side Comparison

How to Think About Which One Fits

There’s no universal answer here. The right account depends on your income, whether you have employees, how you file your taxes, and whether strategies like the backdoor Roth are part of your financial plan.

The SEP IRA can be the better fit if you have employees, want to minimize complexity, or need the flexibility to decide late in the year. The Solo 401(k) can make more sense for owner-only businesses looking to maximize contributions or preserve access to Roth strategies.

One other difference worth knowing: Solo 401(k) plans that allow participant loans give you the ability to borrow from your own account, SEP IRAs don’t.

Either way, this is a decision worth making deliberately, ideally with your CPA and financial advisor.

Interested in learning more? Click Here to see what Dornick can do for you.

Dornick Wealth Management LLC (“Dornick”) is a registered investment advisor in Texas and other jurisdictions where exempted. Registration as an investment advisor does not imply any specific level of skill or training.

The content of this newsletter is for informational purposes only and does not constitute financial, investment, tax, legal, or accounting advice. While efforts are made to ensure accuracy, the information may not be complete, up to date, or applicable to your individual circumstances. It is not an offer or solicitation to buy or sell any securities or investments, nor does it endorse any specific company, security, or investment strategy. Readers should not rely on this content as the sole basis for any investment or financial decisions.

Past performance is not indicative of future results. Investing involves risks, including the potential loss of principal. There is no guarantee that any investment strategies discussed will result in profits or avoid losses.

All information is provided “as-is” without any warranties, express or implied. Dornick does not warrant the accuracy, completeness, or reliability of the information presented. Opinions expressed are those of the author, Levi Pettit, and are subject to change without notice.

No advisor-client or fiduciary relationship is formed by use of this blog or newsletter. For advice tailored to your personal situation, please consult with a qualified financial advisor, tax professional, or attorney.

Dornick is not responsible for any errors or omissions, nor for any direct, indirect, or consequential damages resulting from the use or reliance on this information. Use of the content is at your own risk. This content is not intended as an offer or solicitation in any jurisdiction where such an offer or solicitation would be illegal.

529s: The “College Account” That’s Actually a Bigger Financial Planning Tool

Levi Pettit, CFA, CFP® — Tue, 20 Jan 2026 23:47:02 GMT

What is a 529?

A 529 plan is a state-sponsored education savings account.

You contribute after-tax dollars, invest the money (usually in mutual fund/ETF style portfolios), and if used for qualified education expenses, the growth and withdrawals are typically tax-free at the federal level.

Think of it like a Roth-style account for education goals. Meaning you don’t get a federal deduction going in, but you may get tax-free growth and tax-free qualified withdrawals coming out.

The Core Benefits (Why 529s Belong in Real Financial Plans)

1) Tax-free compounding (when used correctly)

The biggest advantage isn’t the account. It’s the time.

When you start early—especially when kids are young—you’re giving the account the one thing money can’t buy later: a long runway for compounding.

2) It’s more flexible than most people realize

A 529 isn’t just “college or bust.” Qualified uses can include:

K–12 tuition (up to $20,000 per year, per student)
Registered apprenticeship programs
Student loan repayment (up to $10,000 lifetime per individual)

That matters because families rarely have just one education path. Trade school, delayed college, part-time programs, or a late pivot can all still fit.

3) You (the owner) keep control

This is one of the most underrated planning features.

In most cases, the account owner controls:

investments
when distributions happen
beneficiary changes

If you’re writing checks for education anyway, 529s help you do it with more structure and potentially better tax efficiency.

The Strategies Most People Miss

Strategy #1: “Superfunding” (5 years of gifting in one year)

If you want to front-load education funding (and potentially reduce your taxable estate), 529s have a unique move:

You can contribute up to 5 years’ worth of the annual gift tax exclusion at once and elect to spread it over five years for gift tax purposes.

For 2026, that’s often discussed as:

$95,000 per beneficiary (single)
$190,000 per beneficiary (married couple)

Why it’s powerful:

You accelerate compounding early (when it matters most).
You move assets out of your estate while still retaining control of the account.

Important detail: this usually involves gift tax reporting mechanics (even if no tax is due), so it’s something to coordinate with your CPA.

Strategy #2: The new “grandparent 529” advantage (FAFSA change)

Historically, grandparent owned 529 distributions could hurt financial aid because they were treated as student income.

That changed with the simplified FAFSA: distributions from a grandparent owned 529 generally no longer need to be reported as student income starting with the 2024–2025 academic year.

What this means in practice:

Grandparents can help pay for education without the old “aid penalty” dynamic (for FAFSA-based aid).
Families can be more intentional about who owns the 529 and when distributions happen.

As always: aid formulas and school-specific methodologies can vary, but this FAFSA shift is a meaningful planning tailwind.

Strategy #3: The “unused 529 convert to Roth IRA” safety valve (SECURE 2.0)

This is the rule change that made a lot of families breathe easier about overfunding.

Under SECURE 2.0, unused 529 funds can be rolled into a Roth IRA for the beneficiary, subject to several limits:

Up to $35,000 lifetime per beneficiary
The 529 must generally be open at least 15 years
Contributions (and earnings on those contributions) from the last 5 years generally can’t be moved
The rollover is limited by the annual Roth IRA contribution limit and the beneficiary generally needs earned income

Main takeaway: a well-timed 529 can become a “head start” retirement account for your kid later, if education costs come in under budget.

Strategy #4: “Re-assign” the goal instead of breaking the plan

If one child doesn’t need it (scholarship, different path, etc.), you may be able to change the beneficiary to another qualifying family member without federal tax consequences.

That can mean:

sibling to sibling
child to grandchild (future)
child to yourself / spouse (graduate school, continuing ed, etc.)

This is one reason I like 529s as a “family education fund” instead of “Child A’s account that must be used by age 22.”

How to Pick a 529 (Without Getting Lost in the Weeds)

Most families overcomplicate the selection process. A simple framework:

Check your state tax benefits
Some states offer a deduction/credit for contributions to their in-state plan. Others don’t. This can be a big deciding factor.
Compare fees and investment options
Low cost + solid index/age-based options usually wins.
Automate it
A modest monthly auto-contribution often beats a lump sum later because later gets busy.
The Bottom Line
A 529 is one of the few tools that checks multiple boxes at once:
- tax-efficient education funding
- planning flexibility (K–12, apprenticeships, student loans)
- estate planning leverage via superfunding
- and now, a legitimate backstop with 529 to Roth rollovers
For those with kids, a 529 isn’t just “nice to have.” It’s one of the cleanest ways to turn future education costs into a planned, tax-smart part of your bigger strategy.
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The Backdoor Roth IRA: A Big Opportunity Most Miss

Levi Pettit, CFA, CFP® — Mon, 08 Dec 2025 19:39:54 GMT

For many families in their peak earning years, there’s still a way to get money into a Roth IRA each year, even if your income is over the limit. It’s called a Backdoor Roth IRA, and while the name sounds like a loophole, it’s really just a sequence of steps that uses existing IRS rules.

In this piece, I’ll walk through:

Why Roth dollars are so valuable
How the backdoor Roth works
The one big trap (the pro-rata rule)
Who this strategy tends to fit and who should probably skip it

In under a 5 minute read.

Why Roth Dollars Matter So Much

Quick refresher on Roth IRAs:

You contribute after-tax dollars.
The money grows tax-free.
Qualified withdrawals in retirement are tax-free as well (after age 59½ and once the account has been open at least 5 years).
Unlike traditional IRAs, there are no required minimum distributions (RMDs) during your lifetime.

The catch: if your income is above certain thresholds, the IRS phases out and eventually disallows direct Roth contributions.

For 2025, for example, Roth IRA contributions phase out for married couples filing jointly once your Modified Adjusted Gross Income (MAGI) crosses into the mid-$200k range, and single filers hit limits in the mid-$100k range.

That’s where the backdoor Roth comes in.

What Is a Backdoor Roth?

A backdoor Roth isn’t a special account, it’s a two-step process:

Make a non-deductible contribution to a Traditional IRA (funded with after-tax dollars).
Convert those dollars from the Traditional IRA to a Roth IRA.

Because Roth conversions themselves have no income limit, high earners can effectively “sneak in through the side entrance” by contributing to a Traditional IRA and then converting.

Done correctly, this can give you the same end result as a direct Roth contribution: tax-free growth and tax-free qualified withdrawals.

The Simple Version: How It Works

Let’s say you’re married filing jointly, your income is too high to contribute directly to a Roth, and you want to get $7,000 into a Roth IRA for 2025.

Here’s the clean version of the backdoor Roth:

Open a Traditional IRA (if you don’t already have one).
Contribute $7,000 of after-tax money for 2025 (non-deductible contribution).
Soon after, convert that $7,000 from the Traditional IRA to a Roth IRA.

If you have no other Traditional, SEP, or SIMPLE IRA balances and you convert right away before the money has a chance to grow, there’s usually no additional tax bill – you’re essentially just moving already-taxed dollars from one IRA to another, with the “cost” being a bit of paperwork and coordination, not more tax.

On paper, it sounds wonderfully simple.

In reality, there’s one rule that trips people up.

The Big Trap: The Pro-Rata Rule

If you remember nothing else from this article, remember this:

The backdoor Roth works best when you don’t have other pre-tax IRA money.

Why? Because of the pro-rata rule.

The IRS doesn’t look at each IRA in isolation. For tax purposes, it looks at all of your non-Roth IRAs—Traditional, rollover, SEP, SIMPLE—as one big bucket. When you convert, the IRS treats the conversion as coming proportionally from the pre-tax and after-tax dollars in that big bucket.

A quick example

Suppose:

You already have $93,000 in pre-tax Traditional IRA money from an old rollover.
You put in a new $7,000 non-deductible contribution (after-tax) and then convert $7,000 to a Roth.

Total IRA balance: $100,000
After-tax portion: $7,000 (7%)
Pre-tax portion: $93,000 (93%)

Under the pro-rata rule, 93% of your conversion is taxable, even though you meant to just convert the new after-tax money.

So on that $7,000 conversion:

About $6,510 would be taxable.
Only about $490 would be treated as after-tax basis.

This doesn’t automatically mean the strategy is bad, but it’s very different from what many people have in mind.

A Common Workaround: The “IRA Clean-Up”

If you’re a high earner with no existing IRA balances, the backdoor Roth is usually straightforward to evaluate.

If you do have existing pre-tax IRA money, one typical planning move is:

Roll your pre-tax IRA balances into a 401(k) or other workplace plan, as long as your plan allows it.

This can empty your Traditional IRA of pre-tax dollars by the end of the year, leaving only the after-tax contribution behind. When done correctly, this can significantly reduce or eliminate the pro-rata problem on that year’s conversion.

This kind of clean up needs to be coordinated before December 31 of the conversion year, and it has to fit within your broader retirement and investment strategy. It might not always be worth the effort.

Who the Backdoor Roth Often Fits

Every situation is different, but here are profiles where I often see the backdoor Roth make sense to evaluate:

High earners in their 30s–50s
Income too high for direct Roth contributions, but decades of compounding still ahead.
Strong savers maxing other tax-advantaged buckets
You’re already doing 401(k)/403(b)/HSA contributions and still have capacity to save more.
No (or manageable) existing IRA balances
Either you have no Traditional/SEP/SIMPLE IRAs, or it’s realistic to roll them into an employer plan.
Long time horizon and stable cash flow
You’re not likely to need these Roth dollars in the next few years; they can sit and grow.

On the other hand, the strategy can be less compelling if:

You’ve got large pre-tax IRA balances and no good rollover destination.
Your cash flow is tight and you’re not maxing employer plans or paying down high interest debt.
You’re uncomfortable with the extra complexity in your tax filing (Form 8606, tracking basis, etc.).

How to Decide if It’s Worth It

Before you jump in, I’d walk through three questions:

Are you already using the basics?
- Employer retirement plan (especially if there’s a match)
- HSA, if eligible
- Emergency fund and high interest debt under control
Do you have IRA clutter?
- Old rollover IRAs from previous jobs
- SEP or SIMPLE IRAs from self-employment
- If yes, does your current employer plan accept roll-ins?
Is the juice worth the squeeze?
- For many high earners, getting $7,000–$14,000 per year (for a couple) into Roth dollars for 10–20+ years can be very meaningful.
- But the benefit needs to justify the added complexity, tax coordination, and time.

Final Thoughts

The backdoor Roth IRA is one of those strategies that gets thrown around casually on the internet, but the details matter:

It can be very powerful for the right household.
It can also be surprisingly taxable if you overlook the pro-rata rule.
And it should be evaluated in the context of your whole plan, not in isolation.

If you’re a high earner wondering whether this fits into your situation, the next best step is usually a simple one: sit down with a planner or tax professional, put your actual account balances and income on the table, and run the numbers.

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Should You Sell or Rent Out Your Home? Consider Section 121 First

Levi Pettit, CFA, CFP® — Mon, 24 Nov 2025 23:23:07 GMT

The Tax Code’s Gift to Homeowners: Section 121

Section 121 of the Internal Revenue Code can be the home seller’s ace. If you’ve owned and lived in your house for at least 2 out of the last 5 years, you can exclude up to $250,000 of gain from taxes if you’re single, or $500,000 if you’re married filing jointly (IRS Topic 701, Publication 523).

That’s not deferral. That’s tax-free.

Example:

Bought for $400,000, sell for $700,000 = $300,000 gain.
If you’re married and qualify, you pay $0 in capital gains tax.

How to Qualify?

It’s pretty simple to get the capital gains exclusion:

You must own and use the home as your primary residence for at least 2 years within the 5 years before you sell.
The years don’t have to be consecutive.
You can only use the exclusion once every two years.

Why This Matters for Renting

If you move out and start renting, the clock begins ticking.

You can still sell and claim the exclusion as long as you meet the “2 in 5” test.
But the longer you rent, the closer you get to losing eligibility.
After you’ve been out of the house more than 3 years, you’re likely ineligible. Therefore, your gain on the home becomes taxable.

Things to Consider:

Renting out your home can be a great way to generate income, but consider these first:

Depreciation: You must depreciate the property while it’s a rental. When you sell, any depreciation taken is “recaptured” and taxed, even if you qualify for Section 121.
Landlord Duties: Most people who own rental homes will tell you it’s not the easy “passive income” social media claims. Being a landlord can quickly become a overbearing, especially when unexpected expenses pop up.
Partial exclusion: If you sell before two years due to a job move, health, or unforeseen events, you might get a prorated exclusion.

Cases for Selling:

You have significant appreciation and want to lock in the tax-free gain.
You’re not interested in being a landlord, or the local rental market is weak.
You’re approaching the end of your 3-year “grace period” after moving out.

Cases for Renting:

You’re comfortable managing tenants or have a good property manager.
You’re willing to cover any unexpected costs or repairs that might occur.
You plan to move back in, keeping Section 121 on the table.

The Bottom Line

Section 121 is one of the most generous breaks in the tax code and a strong wealth building tool when paired with leverage.

If you’re sitting on big gains, selling your home within 3 years after you move out is often the optimal tax move. Renting can work, but the longer you wait, the more likely you’ll owe the IRS on your appreciation.

If you’re debating, run the numbers both ways. Calculate your potential gain, see if you qualify for the exclusion, and factor in the costs and headaches of being a landlord.

Interested in learning more? Click Here to see what Dornick can do for you.

The content of this newsletter is for informational purposes only and does not constitute financial, tax, legal, or accounting advice. It is not an offer or solicitation to buy or sell any securities or investments, nor does it endorse any specific company, security, or investment strategy. Readers should not rely on this content as the sole basis for any investment or financial decisions.

HSA - The Financial Planning Swiss Army Knife

Levi Pettit, CFA, CFP® — Tue, 11 Nov 2025 23:48:17 GMT

What is an HSA?

An HSA is a special savings account available to people with high-deductible health plans (HDHPs). You put money in tax-deferred, it grows tax-free, and you can use it for qualified medical expenses—today or decades from now — tax-free.

The Triple Tax Advantage

Here’s where HSAs shine from a tax perspective:

Contributions are tax-deductible: Similar to traditional IRA or 401k contributions, the money you put into an HSA reduces your taxable income.
Growth is tax-free: Any interest, dividends, or capital gains within the account are not taxed.
Withdrawals for qualified medical expenses are tax-free: Use the funds from your HSA for qualified medical expenses and pay zero tax.

No other account provides this triple tax advantage.

2025 HSA Contribution Limits

For 2025, you can contribute up to:

$4,300 for individuals (increasing to $4,400 in 2026)
$8,550 for families (increasing to $8,750 in 2026)

If you’re 55 or older, you can add an extra $1,000.

Similar to retirement plan benefits, some companies even provide a dollar for dollar match for your HSA.

HSAs Are Not “Use It or Lose It”

Unlike Flexible Spending Accounts (FSAs), which are use it or lose it, your HSA balance rolls over year after year allowing for that powerful compounding to take place. You keep the money, even if you change jobs or retire.

Invest for the Long Haul

Here’s a pro move: Don’t just use your HSA for this year’s medical bills. If you can afford it, pay out of pocket now and let your HSA funds grow. Many providers let you invest your balance in mutual funds or ETFs, turning your HSA into a stealth retirement account.

If you keep the receipts, you can reimburse yourself for past medical expenses at any time, as long as you had the HSA when the expense occurred. This means you can build up an HSA balance over years while deferring taxes, watch the account grow tax-free, then withdraw the funds tax-free to reimburse yourself for past medical expenses.

Used wisely, HSAs are not just a medical account - they are a powerful part of your long-term financial strategy.

Interested in learning more? Click Here to see what Dornick can do for you.