SEP-IRA vs Solo 401(k): Which Fits Your Business?

A photographer I work with in Montrose had been maxing out a Roth IRA for three years. She was netting around $95,000 a year from her business. She had no idea she was leaving a five-figure tax deduction on the table every year.

Her Roth IRA contribution for 2025: $7,000.

Her maximum SEP-IRA contribution that same year: $18,587.

The difference between those two numbers: roughly $11,500 more deducted: would have saved her close to $3,000 in federal income tax. For three years running. That is almost $9,000 that went to the IRS instead of her retirement account because nobody told her this option existed.

If you are self-employed with no employees, you have two retirement accounts that are built for your situation: the SEP-IRA and the Solo 401(k). They both reduce your taxable income today. They both grow tax-deferred. They have the same maximum contribution limit in 2026. And they work very differently depending on what your income looks like.

How a SEP-IRA Works

SEP stands for Simplified Employee Pension. The name is accurate: it is genuinely simple.

You open one at any major brokerage (Fidelity, Vanguard, Schwab, TD Ameritrade). No plan documents to file with the IRS. No annual reporting unless your account exceeds $250,000. The contribution formula is straightforward: you can put in up to 25% of your net self-employment income, with a cap of $70,000 for 2026 (per IRS Publication 560: verify the current year limit at IRS.gov).

The contribution deadline is your tax filing deadline, including extensions. So if you file on extension in October, you have until October to fund the account for the prior tax year.

SEP-IRA math for a Houston consultant netting $120,000:

• Net self-employment income after the self-employment tax deduction: approximately $113,137
• 25% of that: $28,284
• Maximum SEP-IRA contribution: $28,284
• Federal tax savings (assuming 22% bracket): ~$6,222

That is real money. And the setup takes about 20 minutes online.

How a Solo 401(k) Works

A Solo 401(k): also called an Individual 401(k) or a one-participant 401(k): is structured like the 401(k) you may have had at a previous employer. The difference is that you are both the employer and the employee.

That dual role is what makes it powerful for lower-income self-employed business owners.

You can contribute in two ways:

Employee elective deferral: Up to $23,500 in 2026 (IRS Publication 560). This contribution is not limited by your income: it is a flat dollar amount available as long as you have at least that much in net business income. If you are 50 or older, a $7,500 catch-up provision raises this to $31,000.

Employer profit-sharing contribution: Up to 25% of your net self-employment income. This is the same formula as the SEP-IRA.

Combined, both contributions cannot exceed $70,000 (or $77,500 if you are 50+ and using the catch-up).

You also have the option to open a Roth Solo 401(k), which takes the employee deferral portion after-tax. If you expect your tax rate to be higher in retirement than it is now, the Roth variation is worth considering.

The Solo 401(k) requires slightly more setup: you need an IRS-approved plan document and an Employer Identification Number (EIN). Most major brokerages offer prototype plan documents at no cost. You must establish the plan by December 31 of the tax year you want to contribute for (unlike the SEP-IRA, which can be opened up to the filing deadline).

Why Lower-Income Self-Employed Business Owners Win With the Solo 401(k)

This is the critical point that most people miss.

Both accounts share a $70,000 maximum. But the SEP-IRA’s 25% formula means your actual maximum contribution is entirely tied to your income. If you net $60,000, your SEP-IRA maximum is $14,130. Full stop.

The Solo 401(k)‘s employee deferral of $23,500 is not income-tied. If you net $60,000, you can still contribute up to $23,500 as the employee: which is more than the entire SEP-IRA maximum at that income level.

Comparison at $60,000 net self-employment income:

Account	Maximum Contribution
SEP-IRA	$14,130 (25% of ~$56,520 after SE tax deduction)
Solo 401(k) employee portion only	$23,500
Solo 401(k) total (employee + employer)	$23,500 + $14,130 = $37,630

The Solo 401(k) allows a freelancer in Sugar Land netting $60,000 to shelter more than twice what the SEP-IRA allows at that same income level.

Once income gets high enough: typically around $200,000 or above: the 25% employer contribution alone approaches the $70,000 limit, and the advantage of the employee deferral matters less. At that point, both accounts reach similar effective maximums and the SEP-IRA’s simpler administration is often the better trade.

The Plumber in Pearland vs the IT Consultant in Cypress

Self-employed plumber, Pearland. Net income: $75,000.

SEP-IRA maximum: ~$17,663. Solo 401(k) maximum: $23,500 + ~$17,663 = $41,163.

The Solo 401(k) lets him put away $23,500 more. At a 22% marginal rate, that is an extra $5,170 in tax savings. Over 20 years at 7% growth, that difference in annual contributions compounds to roughly $230,000 in additional retirement savings.

IT consultant, Cypress. Net income: $210,000.

SEP-IRA maximum: ~$49,430. Solo 401(k) maximum: $23,500 + ~$49,430 = capped at $70,000.

Here the difference narrows significantly. The SEP-IRA keeps things simpler with no plan document required and a contribution deadline that extends with the tax filing. For this consultant, the SEP-IRA is likely the better choice purely on administrative simplicity.

If You Have Employees, Neither May Apply

The Solo 401(k) is only available if you have no full-time employees other than a spouse. If you have a full-time employee who is not your spouse, you cannot use it.

The SEP-IRA can cover employees, but it requires you to contribute the same percentage of compensation for every eligible employee that you contribute for yourself. If you put in 20% for yourself, you put in 20% for your bookkeeper, your receptionist, everyone. That changes the cost calculation entirely and often makes the SEP-IRA impractical for businesses with even a few employees.

If you have employees and want a retirement plan, a SIMPLE IRA or a traditional 401(k) plan are worth discussing with your CPA.

The Deadline Difference Matters More Than You Think

SEP-IRA: You can open and fund the account up to your tax filing deadline, including extensions. If you extend to October, you have until October of this year to make last year’s contribution.

Solo 401(k): You must establish the plan by December 31 of the tax year. You can fund it up to your filing deadline: but the plan itself must be set up before year-end. If it is December 28 and you are reading this for the first time, you still have a few days. If it is January, you missed the window for the prior year.

This deadline difference alone is why some people default to the SEP-IRA. The ability to open an account in March and still have it count for last year is genuinely useful when tax season arrives and you realize how much income you generated.

The Decision Framework

Choose the SEP-IRA if:

• Your net self-employment income is above $180,000
• You want the simplest possible setup with no plan documents
• You discovered this option near tax time and need to open and fund before your filing deadline
• You have employees and are willing to contribute for them

Choose the Solo 401(k) if:

• Your net income is under $150,000 and you want to maximize contributions
• You want the Roth option for after-tax retirement savings
• You established the plan before December 31 of the tax year
• You have no full-time employees other than a spouse

Either way, pick one and fund it. Every year you wait is a year of tax savings and compounding growth you cannot get back.

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If you are not sure which account fits your situation or want help calculating the numbers for your income level, describe your problem and we can work through it together.

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