Solo 401(k) vs. SEP IRA: Which Retirement Account Fits Your Self-Employment Income

For a self-employed person with no employees, the solo 401(k) almost always shelters more money than a SEP IRA at the same income, because it stacks an employee deferral on top of the same employer contribution the SEP allows. The SEP IRA wins on simplicity: nothing to file, a deadline that runs to your extended tax return, and a contribution you can size after the year is over. Which one fits depends on how much you want to put away, whether you have or expect employees, and how much paperwork you will tolerate.

Who qualifies for a solo 401(k) and who qualifies for a SEP IRA

A solo 401(k) (also sold as an individual or one-participant 401(k)) is for a business owner with no employees other than a spouse. Any business form works: sole proprietor, single-member LLC, partnership, or corporation, and a side business next to a day job counts. The moment you hire someone who works enough hours to become eligible, the plan stops being a solo plan and has to follow the coverage and testing rules of a full 401(k). The hours threshold that makes a part-timer eligible is set by law and has tightened under recent legislation, so anyone with part-time help should confirm the current rule on IRS.gov before opening one.

A SEP IRA is open to any business, with or without employees, but the deal is symmetric: whatever percentage of pay you contribute for yourself, you must contribute for every eligible employee. Eligibility is broad (an age floor, a few years of service, and a small earnings minimum, all defined by the IRS), so a SEP with employees is a real cost, not a personal account with extras. If you have a small staff and want them to save from their own pay while you add a modest match, the SIMPLE IRA is the third door, built for exactly that.

How the contribution math differs: two layers versus one

A SEP IRA has one layer. The business makes an employer contribution for you, sized as a percentage of your compensation. For a sole proprietor that base is net self-employment earnings: Schedule C profit minus the deductible half of self-employment tax. The statutory rate is 25% of compensation, but for the self-employed the contribution itself is subtracted before compensation is measured, and the circular math collapses to roughly 20% of net earnings. If that sentence made you frown, keep the number: about a fifth of net earnings, and the solo 401(k) calculator runs the loop for you.

A solo 401(k) has two layers. As the employee, you can defer part of your earnings into the plan, up to the annual deferral limit the IRS sets (the same limit that applies to a 401(k) at a job, and shared with one if you have both). As the employer, the business adds the same roughly 20% of net earnings the SEP would. The two layers add, subject to an overall annual cap the IRS also sets and to the earnings themselves; you cannot contribute more than the business made. The employee layer is the whole story: it does not depend on a percentage of profit, so a modest year can still shelter a lot.

Worked example: $60,000 of net profit in each plan

Take a designer with $60,000 of Schedule C profit and nothing else. Self-employment tax runs on 92.35% of that, so $55,410, at 15.3%: about $8,478. Half of it, $4,239, is deductible, and it also comes off the base for the retirement math. Net earnings for plan purposes are therefore $60,000 minus $4,239, or $55,761.

• SEP IRA: 20% of $55,761 is about $11,150. That is the ceiling; the year is done.
• Solo 401(k): the same $11,150 as the employer share, plus an employee deferral. If she defers $15,000 (an illustrative amount inside the annual limit), the plan takes $26,150, more than double the SEP.

At an illustrative combined federal and state marginal rate of 25%, the extra $15,000 of deferral cuts the year's income tax by roughly $3,750; the money is taxed later, at withdrawal, rather than never, but the growth in between is untaxed. Note what neither plan touches: self-employment tax. Retirement contributions are deducted after the 15.3% is figured, so a $26,150 contribution does not shrink the $8,478. The self-employment tax guide walks through why, and the self-employment tax calculator gives the number on your own profit.

The gap narrows as profit rises. The employer share grows with earnings while the deferral is a fixed-size layer, so at high net profit both plans approach the same overall cap and the SEP's simplicity starts to look better. At moderate income, where most freelancers live, the deferral layer is the difference between saving a fifth of profit and saving close to half of it.

Roth, loans, and the other features that differ

Roth. A solo 401(k) can include a designated Roth account, so the employee deferral (and, if the plan document allows it under the 2022 law change, the employer share) can go in after tax and come out tax-free in retirement. A SEP IRA is a traditional, pre-tax account unless your provider offers the Roth SEP option that the same law permits, and many still do not. If tax-free growth matters and the provider cannot offer it, the solo plan is the only route besides a regular Roth IRA.

Loans. Some solo 401(k) plans allow a plan loan, repaid to your own account with interest, up to a limit set by law. A SEP is an IRA, and IRAs cannot lend; taking money out is a distribution with tax and, before 59½, the 10% early-withdrawal penalty. Whether a loan feature belongs in a retirement account is a separate question, but only one of these plans has it.

Your regular IRA. Both plans leave your IRA contribution untouched; SEP and solo 401(k) money does not use the IRA limit. Both also make you "covered by a workplace plan" for the year you contribute, which can restrict the deduction for a traditional IRA contribution above income levels the IRS sets. A Roth IRA is unaffected by coverage.

Paperwork and deadlines: what each plan asks of you

A SEP IRA opens with a one-page adoption agreement and an IRA at any custodian. There is nothing to file with the IRS in any year; the custodian reports contributions. You can open it and fund it as late as your tax filing deadline, including extensions, which means you can finish the year, see the profit, and then decide.

A solo 401(k) needs a written plan document (providers supply a standard one), which must be updated when the law changes, and once plan assets pass a threshold the IRS sets it requires an annual information return (Form 5500-EZ), also due in the year the plan closes. The deadline is the other difference. The employer share can go in up to the filing deadline with extensions, like a SEP. The employee deferral is different: the election to defer generally has to be on record by December 31, because it is a decision to set aside pay you have earned that year. A recent law change lets a sole proprietor with no employees adopt a brand-new plan after year-end and still make a first-year deferral up to the unextended filing deadline, but provider support varies and the rule is narrow, so treat December 31 as the working deadline and verify anything later on IRS.gov.

Practical translation: the SEP is the plan you can decide on in April; the solo 401(k) is the plan you decide on by Thanksgiving.

Solo 401(k) vs SEP IRA: the comparison

The decision rule

1. No employees and you want to put away more than about 20% of net profit: solo 401(k). The deferral layer is the only way to do it.
2. No employees but you want zero paperwork, or profit is too uncertain to commit before December: SEP IRA, with the option to add a solo plan later.
3. You have or will soon have eligible employees: SEP if you are comfortable contributing the same percentage for them, SIMPLE IRA if you want them to fund their own accounts with a modest match, a full 401(k) once the staff is real.
4. You already max the 401(k) at a day job: the deferral limit is shared across every 401(k) you have, so the solo plan's employee layer is already used. Only the employer share is left, which is exactly what a SEP offers; choose on Roth, loans, and provider fees rather than on size.
5. You already have a SEP and profit has grown: open a solo 401(k), stop new SEP contributions, and roll the SEP balance in if the new plan accepts it. Mind the deferral deadline in the first year.

Either plan pairs with the salary-and-buffer system in Money on an Irregular Income: a fixed IRA contribution from every salary payment, and a SEP or solo 401(k) contribution sized once a quarter when the tax picture is clear. The rest of the self-employed toolkit lives in the freelancer money collection.

A retirement account you fund yourself only counts if you can see it next to everything else: the tax buffer, the operating account, the brokerage, and the loan you might one day take from it. Stoia keeps every account, self-employed plans included, in one live net worth picture, launching 2026.