SEP IRA vs. Solo 401(k): Which Retirement Plan Is Best for Self-Employed Business Owners?

The short answer: a Solo 401(k) almost always allows a larger tax-deductible contribution than a SEP IRA at the same income, because it lets you contribute as both the employee and the employer. A SEP IRA caps you at roughly 20% of net self-employment earnings (25% of W-2 wages for S-corp owners). A Solo 401(k) allows that same employer contribution plus an employee deferral of $24,500 in 2026, with an $8,000 catch-up if you are 50 or older. Both plans share the same overall ceiling of $72,000 for 2026. The SEP IRA wins on simplicity and on flexibility for owners who have employees. The Solo 401(k) wins on contribution room, Roth options, and loan access for owners with no employees other than a spouse.

How a SEP IRA works

A Simplified Employee Pension (SEP) IRA is a traditional IRA that the business funds. Only the employer contributes; there is no employee deferral. The contribution limit for 2026 is the lesser of 25% of compensation or $72,000. For an S-corp owner, compensation means W-2 wages, so the math is straightforward: $80,000 of salary allows a $20,000 SEP contribution. For a sole proprietor or single-member LLC filing Schedule C, compensation means net earnings from self-employment, which is net profit minus half of your self-employment tax minus the SEP contribution itself. That circular definition works out to an effective rate of 20% of net profit after the self-employment tax adjustment.

SEP IRAs have almost no administrative burden. There is no annual filing, no plan document beyond IRS Form 5305-SEP or a provider equivalent, and the account can be opened and funded as late as your tax filing deadline, including extensions. A sole proprietor on extension can open a SEP in October and deduct the contribution on the prior year's return. That late deadline is the single biggest practical advantage of the SEP.

The catch is employees. A SEP must cover every employee who is at least 21, has worked for you in three of the last five years, and earned at least $800 in 2026. Every covered employee must receive the same percentage of compensation that you give yourself. If you contribute 20% of your own pay, you contribute 20% of theirs. For an owner with no employees that is irrelevant. For an owner with two or three long-tenured staff it can make the SEP very expensive.

How a Solo 401(k) works

A Solo 401(k), also called an individual or one-participant 401(k), is a standard 401(k) plan designed for a business with no employees other than the owner and the owner's spouse. It allows two separate contributions. As the employee, you can defer up to $24,500 of compensation in 2026, plus an $8,000 catch-up if you are 50 or older, or $11,250 if you are 60 through 63. As the employer, the business can contribute up to 25% of W-2 wages (or the same effective 20% of adjusted net self-employment earnings as a SEP). The two contributions together cannot exceed $72,000, not counting catch-up amounts, which sit on top.

The employee deferral is what makes the Solo 401(k) so much larger at moderate incomes. An owner earning $60,000 can defer $24,500 regardless of the percentage limits, then add an employer contribution. The same owner is capped at roughly $11,000 to $12,000 in a SEP. The gap narrows as income rises and closes entirely around $290,000 of W-2 wages or $360,000 of Schedule C profit, where the 25% or 20% employer contribution alone reaches the $72,000 ceiling.

Solo 401(k) plans also offer features a SEP cannot. Most providers allow a Roth 401(k) option for the employee deferral, so you can pay tax now and withdraw tax-free later. Plans can permit loans of up to 50% of the balance or $50,000, whichever is less. And because deferrals are not limited by the 25% employer percentage, a spouse who earns a modest salary from the business can shelter nearly all of it.

A worked example at $100,000 of profit

Take a sole proprietor under age 50 with $100,000 of net profit on Schedule C in 2026. Self-employment tax is about $14,130, and half of that, $7,065, is deductible. Net earnings for plan purposes are therefore $92,935.

• SEP IRA maximum: 20% of $92,935 = $18,587
• Solo 401(k) employee deferral: $24,500
• Solo 401(k) employer contribution: 20% of $92,935 = $18,587
• Solo 401(k) total: $43,087
• Additional room with the Solo 401(k): $24,500
• If the owner is 50 or older, add an $8,000 catch-up to the Solo 401(k) for a total of $51,087

At a 24% federal bracket, the extra $24,500 of deductible contribution saves roughly $5,880 in federal income tax in the year it is made. Note that neither plan reduces self-employment tax; both are income tax deductions only. The same owner operating as an S-corp paying themselves $80,000 in wages would see a SEP limit of $20,000 and a Solo 401(k) limit of $44,500.

Rule of thumb: below about $290,000 of W-2 wages or $360,000 of Schedule C profit, a Solo 401(k) allows a larger contribution than a SEP IRA. Above that, both plans hit the same $72,000 ceiling and the SEP's simplicity usually wins.

Deadlines and paperwork

A SEP IRA can be established and funded up to the due date of your return, including extensions. A Solo 401(k) is more time-sensitive. Under the SECURE Act, the plan itself can be adopted as late as your filing deadline including extensions, and employer contributions can be made by that same date. Employee deferrals are stricter: for a sole proprietor, the deferral election for the plan's first year must be made by the unextended due date of the return (April 15 for most owners), and in every later year it must be made by December 31. S-corp owners must run deferrals through payroll during the calendar year, so a Solo 401(k) opened after December 31 cannot accept an employee deferral for the prior year at all.

Once a Solo 401(k) holds more than $250,000 in assets at year end, you must file Form 5500-EZ annually. The form is short, but missing it carries a penalty of $250 per day, so it belongs on your compliance calendar. A SEP IRA never requires a 5500.

What happens when you hire someone

This is the question that should drive the decision for many owners. With a SEP, a new employee becomes eligible after working for you in three of the last five years, and then must receive the same contribution percentage you take. With a Solo 401(k), the plan stops qualifying as a one-participant plan as soon as you have a non-spouse employee who meets the plan's eligibility rules, which under SECURE 2.0 includes part-time workers with at least 500 hours in two consecutive years. At that point the plan must either convert to a full 401(k) with nondiscrimination testing, or be terminated and rolled over. Neither outcome is a disaster, but both add cost and should be planned for before the hire, not after.

Which plan should you choose?

• Choose a Solo 401(k) if you have no employees other than a spouse, your income is below roughly $300,000, and you want to contribute more than 20% of your earnings. The employee deferral is the whole reason to pick it.
• Choose a Solo 401(k) if you want a Roth option or the ability to borrow from the plan. SEP Roth contributions became legal under SECURE 2.0 but very few custodians offer them.
• Choose a SEP IRA if the tax year is already over and you have not set anything up. It is the only plan you can open and fully fund after December 31.
• Choose a SEP IRA if you have or expect to have employees and you want to control the cost with a single contribution percentage and no testing.
• Choose a SEP IRA if your income is high enough that the 20% or 25% employer contribution alone reaches $72,000, since the extra plan features of a 401(k) buy you nothing at that point.
• Consider a SIMPLE IRA if you have a handful of employees and want a plan with mandatory but modest employer contributions. The 2026 employee deferral limit is $17,000.

At Stone Valley Accounting, retirement plan selection is part of the fall tax planning conversation, not an afterthought at filing time. The reason is the deadline asymmetry: a SEP can be fixed in April, but a Solo 401(k) deferral has to be elected before the year ends. For an S-corp owner, that also means setting the salary and the payroll deferral early enough that the full $24,500 actually runs through payroll by the last December check. We model both plans at the owner's projected income and show the tax savings side by side, then handle the setup so the contribution and the deduction land on the same return.

Can you have both?

Yes, but it rarely helps. If both plans are sponsored by the same business, contributions to both count toward the single $72,000 limit, so adding a SEP to a Solo 401(k) creates paperwork without creating room. The exception is an owner with a side business that is unrelated to a W-2 job. Contributions to an employer's 401(k) at your day job share the $24,500 employee deferral limit with your Solo 401(k), but the employer contribution limit is per business, so a self-employed side income can support its own employer contribution of up to 20% of net earnings even if you are already maxing out deferrals at work.

Key takeaway: if you have no employees, a Solo 401(k) will almost always let you deduct more than a SEP IRA, but only if it is set up before December 31. If the year is already over, open a SEP, fund it by your filing deadline, and switch to a Solo 401(k) for next year.