SEP IRA vs. Solo 401(k): Which Retirement Plan Saves Self-Employed People More?

SEP IRA vs Solo 401k for self-employed explained by Robert Allen Bautista, Kansas City tax preparer

For self-employed people, a retirement plan is one of the few deductions that also builds your own wealth. The two most popular choices are the SEP IRA and the Solo 401(k). Both can shelter far more than a regular IRA. Here is how they differ and how to choose.

SEP IRA: simple and flexible

  • Who contributes: only the business ("employer") contributions.
  • How much: up to 25% of compensation. For a sole proprietor that works out to roughly 20% of net self-employment earnings after the deduction for half of self-employment tax, up to the annual IRS dollar cap.
  • Deadline: you can open and fund a SEP for the prior year up to your tax filing deadline, including extensions.
  • Paperwork: minimal. Most brokerages open one in minutes.
  • Employees: if you have eligible employees, you must contribute the same percentage for them.

Solo 401(k): usually more room at lower incomes

  • Who contributes: you contribute twice, as the "employee" (elective deferrals, up to the annual limit, with extra catch-up room at 50+) and as the "employer" (up to the same roughly 20% of net earnings).
  • Why it matters: because of the employee deferral, a Solo 401(k) often allows a much larger contribution on the same income, especially below about $150,000 of profit.
  • Roth option: many plans allow Roth deferrals.
  • Eligibility: only for businesses with no employees other than the owner (and spouse).
  • Paperwork: a plan document, and once plan assets exceed $250,000, an annual Form 5500-EZ.

A side-by-side example

A freelancer, age 40, has $60,000 of net self-employment profit. After the self-employment tax adjustment, net earnings for retirement purposes are roughly $55,800.

  • SEP IRA: about 20% × $55,800 ≈ $11,100
  • Solo 401(k): the same ~$11,100 employer piece plus an employee deferral of up to the annual limit (over $20,000), for a potential total above $30,000

At higher profits, the gap narrows, because the employer percentage alone can approach the annual cap.

How to choose

  • Want the biggest possible deduction on moderate income? Solo 401(k).
  • Want simplicity, or deciding after year-end? SEP IRA.
  • Have employees? A Solo 401(k) is off the table; compare a SEP with a SIMPLE IRA or a regular 401(k).
  • Want Roth savings? Look at Solo 401(k) plans with Roth deferrals.

Timing tip

Rules for opening a Solo 401(k) and making the first year's employee deferrals have become more flexible, but deadlines still matter. If you are considering one for this year, set it up before December 31 to keep every option open.

Official IRS sources

This article is general information, not tax or investment advice for your specific situation.

Related guides

About the author

Robert Allen Bautista is a tax preparer and accountant in Kansas City. He spent four years at PwC in IT audit and tax, served as Chief Accountant at a CPA firm, holds an M.S. in Accounting, and is a CPA candidate. He has worked with 350-plus individual and small business clients and writes plain-English tax guides in English and Spanish. More about Robert · Website · LinkedIn 

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