Solo 401(k) vs SEP-IRA for a One-Person Business

Two retirement accounts get recommended constantly to freelancers, consultants, and single-member LLC owners, and they get confused with each other almost as often. A Solo 401(k) (sometimes called an individual 401(k) or one-participant 401(k)) and a SEP-IRA both let a business with no employees other than the owner — and, if applicable, a spouse — make sizable tax-advantaged retirement contributions using self-employment income. Both are funded entirely or mostly by the business rather than payroll withholding in the traditional sense. Both are available at nearly every major brokerage with no setup fee. From there, the similarities mostly end.

The gap that matters most is structural: a SEP-IRA only ever receives one type of contribution — an employer profit-sharing contribution calculated as a percentage of earnings. A Solo 401(k) receives two: an employee elective deferral (the part you’d normally see withheld from a paycheck) and an employer profit-sharing contribution calculated the same way a SEP’s is. That second bucket is what lets a modestly profitable one-person business roughly double its contribution room compared with a SEP-IRA at the same income. This piece walks through exactly how the math works, where each plan’s rules diverge on loans, Roth treatment, and deadlines, and which one actually fits a given income level and business structure.

Contribution Limits and the Math That Actually Drives Them

Every comparison of these two accounts eventually comes down to a formula, and the formula is less intuitive than it looks because “self-employment earnings” isn’t the same number as your net profit on Schedule C.

Why the self-employed contribution rate is 20%, not 25%

Both a SEP-IRA and the employer side of a Solo 401(k) are nominally capped at 25% of compensation. For a business that pays the owner W-2 wages — an S-corporation, for instance — that’s a clean 25% of whatever the owner’s W-2 box 1 wages show. For a sole proprietor, a single-member LLC taxed as a disregarded entity, or a partner in a partnership, there’s no W-2, so the IRS defines “compensation” as net self-employment earnings after two adjustments: first, you subtract the deduction for one-half of your self-employment tax, and second, the contribution itself is treated as reducing the earnings it’s calculated from. Solve that circular equation and the 25%-of-compensation rule collapses to a flat 20% of net self-employment earnings (net profit minus the deductible half of SE tax). Most SEP-IRA and Solo 401(k) calculators build this adjustment in automatically, but it’s worth knowing the mechanism, because it explains why an unincorporated owner’s contribution ceiling is always noticeably lower than a naive 25%-of-profit estimate would suggest.

The 2026 numbers that set the ceiling

For the 2026 tax year, the relevant figures are: an employee elective deferral limit of $24,500 for a Solo 401(k), an additional catch-up contribution of $8,000 for participants age 50 and older, and a larger “super” catch-up of $11,250 for participants who turn 60, 61, 62, or 63 during the year. The overall combined limit — employee deferral plus employer contribution, across both plan types — is $72,000, or $80,500 with the standard catch-up, or $83,750 with the age 60-63 super catch-up. The compensation cap used in the 25%/20% formula is $360,000. A SEP-IRA has no separate deferral bucket, so its ceiling is simply 20% of net self-employment earnings, up to that same $72,000 combined limit. A Solo 401(k) gets the employee deferral on top of that identical 20% employer contribution, subject to the same overall cap.

That structural difference is the entire reason a Solo 401(k) tends to beat a SEP-IRA on pure contribution room at low-to-mid six-figure income, and it’s also why the gap closes as income rises — once net earnings are high enough that 20% alone reaches $72,000, adding a deferral on top does nothing more, since the combined cap has already been hit.

Roth Access, Participant Loans, and Mid-Year Flexibility

Contribution room is the headline difference, but three secondary features separate these accounts in ways that matter once you get past the spreadsheet.

Roth treatment

A Solo 401(k) has offered a Roth option for the employee deferral portion for years at virtually every provider — Fidelity, Schwab, and E*TRADE all support it with no extra fee. Since 2023, SECURE 2.0 technically allows Roth SEP contributions too, but adoption among custodians has been slow; several major brokerages still only offer traditional, pretax SEP-IRAs, and a Roth employer profit-sharing contribution inside a Solo 401(k) is even rarer in practice, though a growing number of specialist administrators now support it. If getting new contributions into a Roth account is a priority, the Solo 401(k) is the safer bet today, mainly because it’s the option your custodian is far more likely to actually have built.

Loans

A Solo 401(k) permits participant loans of up to $50,000 or 50% of the vested balance, whichever is smaller, repayable over five years (longer for a primary-residence purchase). A SEP-IRA, being an IRA at its core, cannot make loans to the account owner under any circumstances — borrowing from it is treated as a distribution, and an early one at that if you’re under 59½. For an owner who wants a documented, in-plan borrowing option as a backstop against a slow month, that alone can tip the decision toward the 401(k) structure.

Mid-year flexibility versus one annual decision

A Solo 401(k)’s employee deferral works like a payroll election: you can adjust or stop it during the year as cash flow shifts, then true up the employer profit-sharing contribution once you know full-year numbers. A SEP-IRA has just one moving part — a single employer contribution decided and made after the year closes, with nothing to elect or adjust along the way. For an owner who prefers not to think about retirement contributions until tax season, that simplicity is a feature, not a limitation.

Paperwork, Deadlines, and Ongoing Compliance

This is the category where SEP-IRAs have historically won outright, and where a 2023 rule change narrowed — but didn’t eliminate — the gap.

Opening the plan

A SEP-IRA can be opened and fully funded any time up to your tax filing deadline, including extensions, for the prior year. There’s no year-end deadline at all. A Solo 401(k), for years, had to be legally adopted by December 31 of the tax year in order to accept an employee deferral for that year, even though the actual cash could be deposited later. SECURE 2.0 changed this for brand-new plans: a sole proprietor or single-member LLC with no common-law employees can now adopt a first-year Solo 401(k) as late as the tax filing deadline (including extensions) and still make both the employee deferral and employer contribution for the year just ended. The catch is that this grace period only applies the first time you set the plan up; once it exists, future years’ deferral elections still need to happen before the calendar year closes.

Ongoing filings

A SEP-IRA never requires an annual filing with the IRS, regardless of balance. A Solo 401(k) must file a one-page Form 5500-EZ once combined plan assets exceed $250,000 at year-end (and a final 5500-EZ when the plan is terminated, regardless of balance). It’s a short form and most owners can file it themselves in under twenty minutes, but it is one more recurring task the SEP-IRA simply never generates.

What happens the moment you hire someone

Neither account stays this simple once real employees enter the picture, and the SEP-IRA’s eligibility rule catches people off guard more often than the 401(k)’s. A SEP-IRA must cover any employee who is at least 21, has worked for the business in at least three of the last five years, and earned at least the SEP minimum compensation threshold ($800 for 2026) — and it must give that employee the identical contribution percentage the owner takes for themselves. A part-time bookkeeper you hired two summers ago can trigger this even if they’ve since left. A Solo 401(k) that starts covering non-owner employees stops being “solo” and becomes a standard 401(k) subject to nondiscrimination testing, which is its own headache, but the eligibility rules for a 401(k) can be written more restrictively (up to a one-year, age-21 wait) than a SEP’s, giving an owner a bit more runway before a new hire’s balance has to be funded.

Cost and Provider Availability

At the big three discount brokers — Fidelity, Schwab, and E*TRADE — both a SEP-IRA and a plain-vanilla Solo 401(k) are free to open and carry no annual account fee, and the investment menu is whatever you’d get in a regular brokerage account: index funds, ETFs, individual stocks, and bonds. Where cost differences show up is at the edges. If you want a Solo 401(k) with participant loans, Roth employer contributions, or “checkbook control” to invest in real estate, private placements, or cryptocurrency, you’ll generally need a specialist third-party administrator such as My Solo 401k Financial, Rocket Dollar, Carry, or Ubiquity, and those typically charge a setup fee in the $500-$700 range plus $100-$300 a year afterward. A SEP-IRA, by contrast, stays inexpensive almost everywhere because it’s structurally simpler — there’s no plan document to customize and no loan feature to administer — but that same simplicity is exactly why it can’t offer those features at any price.

Solo 401(k) vs SEP-IRA: The Comparison Table

Worked Example: Same Business, Two Very Different Contribution Ceilings

Numbers make the gap concrete. Take a single-member LLC taxed as a sole proprietorship, no employees, owner under 50.

Case A: $120,000 in net profit

After the deduction for one-half of self-employment tax, net self-employment earnings come out to roughly $111,522. A SEP-IRA contribution is capped at 20% of that figure — $22,304. A Solo 401(k) starts from the same $22,304 employer contribution but adds the full $24,500 employee deferral on top, for a total of $46,804. The Solo 401(k) shelters more than double what the SEP-IRA allows, using the exact same underlying business income.

Case B: $350,000 in net profit

At this income, net self-employment earnings land around $333,930. Twenty percent of that is $66,786 — still under the $72,000 combined cap, so the SEP-IRA contribution is $66,786. The Solo 401(k) would theoretically call for $24,500 in deferral plus $66,786 in employer contribution, but the combined federal cap steps in at $72,000, so the employer piece gets trimmed to $47,500 and the total lands exactly at the $72,000 ceiling. The dollar gap between the two plans has narrowed from roughly $24,500 down to about $5,214, purely because both are now bumping into the same statutory wall.

The crossover point is worth naming directly. A Solo 401(k) hits the $72,000 federal ceiling once net self-employment earnings reach about $237,500, because the $24,500 deferral fills part of that ceiling before the 20% employer formula even has to do the heavy lifting. A SEP-IRA doesn’t reach that same $72,000 ceiling until net self-employment earnings reach roughly $360,000, since every dollar of it has to come from the 20% employer calculation alone. Between those two thresholds, the Solo 401(k) has already maxed out while the SEP-IRA is still climbing toward it — which is really just a restatement of the same structural point from a different angle.

When Each Plan Wins

Pick the Solo 401(k) if…

Your net self-employment earnings sit below roughly $237,500 and you want to shelter as much as legally possible; you’d like the option of a Roth account for new contributions; you want a loan feature available even if you never end up using it; or you’re 50 or older and want the extra catch-up room, which only exists on the deferral side and therefore only helps inside a 401(k) structure.

Pick the SEP-IRA if…

You want to open and fund a plan with the least possible paperwork and no annual filing obligation, ever; your income is already well past the point where both plans hit the same ceiling, so extra plan complexity buys you nothing; your contribution decisions vary wildly year to year and you’d rather make one lump employer decision after your books close than manage an ongoing deferral election; or you’re setting up retirement savings for a very new business and don’t yet know whether you’ll want loan access or Roth treatment down the line.

Common Mistakes One-Person Business Owners Make

A handful of errors show up again and again in this decision, and most of them are avoidable with a little planning.

Assuming the SEP-IRA’s 25% figure applies directly to net profit. As covered above, an unincorporated owner’s real ceiling is closer to 20% of net earnings after the self-employment tax adjustment, not 25% of gross profit. Plugging raw net profit into a 25% calculation overstates the allowed contribution and can trigger an excess contribution that has to be corrected before the tax deadline.

Forgetting the December 31 deadline for an existing Solo 401(k)’s deferral election. The SECURE 2.0 grace period for opening a brand-new plan late doesn’t apply once the plan already exists. An owner who waits until March to “decide” on last year’s deferral for a plan opened two years ago will find that option gone; only the employer contribution can still be made up to the filing deadline.

Hiring seasonal or part-time help without checking SEP eligibility rules. Because SEP-IRA eligibility looks back three of the last five years, a former part-time employee can still trigger a mandatory employer contribution obligation long after they’ve stopped working for you, and at the same percentage the owner takes.

Treating an S-corp’s reasonable-compensation number as optional. If your one-person business is taxed as an S-corporation, both plans calculate the 25%/20% formula off your W-2 wages, not total business profit. Underpaying yourself in wages to save on payroll tax also shrinks your retirement contribution ceiling — a trade-off many new S-corp owners don’t realize they’re making until they run the numbers.

Overlooking rollover flexibility when switching plans. A SEP-IRA and a Solo 401(k) can generally be rolled into each other or consolidated, but timing it around your current-year contributions matters; funding both in the same year for the same income can inadvertently create an excess combined contribution across accounts, since the $72,000 (or catch-up-adjusted) ceiling applies in aggregate, not per plan.

For a broader look at the errors that trip up retirement savers across account types — not just self-employed ones — the rundown in 5 Retirement Account Mistakes to Avoid covers several patterns that apply here too, particularly around deadlines and account-type mismatches.

A Practical Checklist Before You Open Either Account

• Confirm your business truly has no common-law employees other than yourself and, if applicable, your spouse — both plans depend on that.
• Estimate your net self-employment earnings for the year (net profit minus the deductible half of SE tax) before comparing contribution ceilings.
• If you’re incorporated as an S-corp, run the math off projected W-2 wages instead of business profit.
• Decide whether Roth treatment, participant loans, or checkbook control over alternative assets matter to you — if any of them do, lean Solo 401(k) and check that your chosen provider actually supports the specific feature you want.
• If opening a brand-new Solo 401(k) after year-end, confirm with your provider that they support the SECURE 2.0 late-adoption rule for first-year plans before assuming you can still claim a deferral for the prior year.
• Set a calendar reminder for December 31 for any Solo 401(k) deferral election in future years — this deadline does not move once the plan exists.
• Track combined plan assets if you have a Solo 401(k), since Form 5500-EZ becomes due the year balances cross $250,000.
• Revisit the decision if your income or business structure changes meaningfully — a plan that made sense at $90,000 in net earnings may not be optimal at $300,000.

Key Takeaways

• A Solo 401(k) adds an employee deferral (up to $24,500 in 2026, more with catch-up) on top of the same employer contribution formula a SEP-IRA uses, which is why it typically allows a larger total contribution at low-to-mid six-figure income.
• Both plans share the same $72,000 combined 2026 ceiling, and a SEP-IRA needs roughly $360,000 in net self-employment earnings to reach it, versus about $237,500 for a Solo 401(k).
• SEP-IRAs never require an annual IRS filing; Solo 401(k)s need a Form 5500-EZ once assets top $250,000.
• Only a Solo 401(k) allows participant loans; SEP-IRAs cannot lend to the account owner under any circumstance.
• Hiring even a part-time or seasonal employee can trigger mandatory SEP-IRA contributions on their behalf based on a three-of-five-year lookback, a rule that catches many owners off guard.

Frequently Asked Questions

Can I have both a Solo 401(k) and a SEP-IRA at the same time?

Yes, both can exist simultaneously for the same business, but the $72,000 combined 2026 limit (or the catch-up-adjusted version) applies across the two accounts together, not separately to each one. Most owners find little practical benefit to running both at once and pick one to simplify recordkeeping.

What happens to my SEP-IRA or Solo 401(k) if I hire an employee?

A SEP-IRA must extend the same contribution percentage to any employee who meets its eligibility rules, which can include someone who worked for you in three of the last five years. A Solo 401(k) that starts covering non-owner employees becomes a standard 401(k) subject to broader nondiscrimination testing, though its eligibility terms can sometimes be written to delay coverage longer than a SEP’s rules allow.

Can I convert an existing SEP-IRA into a Solo 401(k)?

You can roll SEP-IRA assets into a Solo 401(k) once the 401(k) is established, and many owners do this specifically to unlock loan access or Roth treatment. The rollover itself is generally not a taxable event, but you should coordinate the timing with your tax preparer to avoid overlapping the same year’s contributions across both plans.

Does a Solo 401(k) or SEP-IRA lower my self-employment tax?

No. Contributions to either plan reduce your income tax by lowering adjusted gross income, but self-employment tax is calculated on net self-employment earnings before either plan’s contribution is subtracted. Neither account reduces the Social Security and Medicare portion of your tax bill.

Is a Roth Solo 401(k) actually available, and is it worth using?

Yes, most major providers offer a Roth option for the employee deferral portion of a Solo 401(k) at no extra cost. Whether it’s worth using depends on whether you expect to be in a higher tax bracket in retirement than you are now; if your business income is currently modest but growing, paying tax now on a smaller deferral can be an attractive trade.

What’s the deadline to open and fund each plan for the current tax year?

A SEP-IRA can be opened and funded any time up to your tax filing deadline, including extensions. A brand-new Solo 401(k) can also now be opened that late under SECURE 2.0, but only in its first year; once it exists, future employee deferral elections must be made by December 31, even though the actual contribution can still be deposited later.

References

• Internal Revenue Service, “Retirement Topics – Contribution Limits” and annual cost-of-living adjustment announcements for 401(k) and SEP plans.
• Internal Revenue Service, “One-Participant 401(k) Plans” guidance.
• Internal Revenue Service, “SEP Plan FAQs – Establishing a SEP.”
• SECURE 2.0 Act of 2022, Section 317 (post-year-end plan adoption for sole proprietors) and Section 601 (Roth treatment of SEP and SIMPLE contributions).
• Social Security Administration, annual wage base determination.