Solo 401(k) vs. SEP
Updated: 5 days ago
Key Takeaways
Many high-earning self-employed individuals are not contributing as much to their retirement accounts as they’re allowed.
Many accountants automatically recommend SEP IRAs, but they’re not always the best option.
Solo 401(k)s allow dual employee and employer contributions, enabling higher total retirement savings than SEP IRAs. New Jersey residents can get special deductions for Solo 401(k) contributions.
Whether you’re a lifelong entrepreneur or starting a new career after a long tenure in the corporate or academic world, many of you are making substantial incomes as consultants, independent contractors, or solo-preneurs. You may not think of yourself as a traditional business owner, but in many cases you are. And that means you could be saving a lot more for retirement than you think.
For people in your situation, accountants have long recommended a Simplified Employee Pension (aka SEP), which is a type of retirement plan primarily used by small businesses and self-employed individuals to save for retirement. A SEP IRA allows you (i.e., your employer) to make tax-deductible contributions to your individual retirement account and to the IRAs of any future employees. Accountants like SEP IRAs because they are simple and inexpensive to set up and administer. And sole proprietors can contribute up to 25% of their net business income (as reported on their tax return) with a maximum contribution of $72,000 for 2026 if you’re under age 50, with additional catch-up amounts for those over 50 and between 60-63 (more on that in a minute).
$72,000 a year may sound like a healthy amount to contribute to your nest egg, but in many cases, you would be even better off with a Solo 401(k). A solo 401(k), also known as an individual 401(k), is a retirement plan designed specifically for self-employed individuals and business owners who have no employees (except for a spouse). As a sole proprietor, a Solo 401(k) allows you to contribute to your account as both employer AND employee. This offers significant tax advantages and higher contribution limits than traditional IRAs.
Part 1: Employee Contribution (Elective Deferral):
Individuals under 50 can contribute up to $24,500 as an employee.
Those 50 and older can make an additional catch-up contribution of $8,000, for a total of $32,500.
For those aged 60 to 63, the catch-up contribution is $11,250, resulting in a total employee contribution of $35,750.
Part 2: Employer Contribution (Profit-Sharing):
As the employer, you can contribute up to 25% of your compensation (or net self-employment income).
The maximum compensation that can be used to calculate your employer contribution is $360,000 in 2026.
This means that the maximum employer contribution could be $90,000, but the combined employee and employer contributions cannot exceed $72,000 (or $80,000/$83,250 with catch-up).
Real-World Example
Let’s say you’re a 50-year-old sole proprietor with a business income of $370,000 (i.e., the net income from your tax Schedule C or C-EZ). To calculate your maximum contribution, we assume you have maximized all of your business contributions and elective deferrals. The table below summarizes the Individual 401(k) contribution calculation along with SEP IRAs and SIMPLE IRAs:
Calculations
For the 2026 tax year, the individual 401(k) contribution limit is $72,000. However, it goes up to $77,500 if you're age 50 or older -- and to $81,250 if you're between the ages of 60 and 63. These limits apply to the combined contributions from both the employee and employer portions of the plan. As you can see, our 50-year-old sole proprietor would be able to contribute a combined $77,500 via a Solo 401(k) vs. $70,000 for a SEP IRA and only $30,194 for a SIMPLE IRA.
Many people, including accountants used to shy away from Solo 401(k)s, because they were more complicated and expensive to set up and maintain than SEP IRAs. Over the last decade, however, major custodians such as Vanguard, Fidelity and Schwab greatly simplified the paperwork and set up requirements for Solo 401(k)s and they’re now free. You just have to file Form 5500 every year once your account balance goes above $250,000.
What sets the Solo 401(k) apart is the ability to contribute both as an employee and an employer, giving you incredible flexibility to maximize your savings. This dual structure means that even if your income isn’t sky-high, you can still make significant contributions, especially when compared to the SEP IRA. Another major benefit of the Solo 401k is the option to include a Roth component, allowing you to make after-tax contributions that grow tax-free. If you expect to be in a higher tax bracket in the future, this can be very advantageous.
Roth Solo 401(k)s
A Roth feature is only available to Solo 401ks for employee contributions with the free prototype plans offered by financial institutions. The Secure Act 2.0 allowed both Roth SEP IRAs and Roth employer contributions for solo 401(k)s starting in 2023, but no company has made these features available yet. Some business owners have tried to circumvent this by making contributions to their traditional SEP IRA and then doing a Roth conversion to a Roth IRA. It’s like a back door Roth IRA contribution, but there is a major flaw to this method – it decreases the business owner’s Qualified Business Income (QBI) tax deduction and thus increases their tax liability. IRS guidance about how the Roth employer contribution for Solo 401ks and SEPs should be reported suggests that these contributions would have the same flaw if they became available.
New Jersey taxpayers. Note that the Garden State does not allow state income tax deductions for SEP IRAs, but it does for Solo 401ks, yet another check mark in favor of the Solo 401(k).
Conclusion
If you or someone close to you is evaluating the best way to maximize retirement savings, understanding the differences in a Solo 401(k) vs SEP plan is essential. The right choice can significantly impact how much you’re able to contribute—and how efficiently you can reduce your tax burden. If you’d like help reviewing your options or determining which plan best supports your long-term goals, please reach out anytime. I’m always happy to help.
Devin Starr, CFP®, Associate Wealth Advisor at Novi Wealth
