Solo 401(k) vs. SEP-IRA: retirement plans for the self-employed

Self-employment takes away your employer match and hands you something better in exchange: the ability to be both employee AND employer for retirement purposes, sheltering tens of thousands of dollars a year. The two main vehicles are the Solo 401(k) and the SEP-IRA. They have the same headline contribution ceiling, which fools people into thinking they're interchangeable. At most income levels, they're not — and the differences are worth real money.

The SEP-IRA: simple, but one-dimensional

A SEP-IRA lets you contribute as the 'employer' only: roughly 25% of W-2 wages, or about 20% of net self-employment profit for sole proprietors, up to a cap of $70,000 (2025). Setup takes minutes at any brokerage, there's no annual IRS filing, and you can even open and fund one up to your tax-filing deadline, extensions included. The weakness: everything is a percentage of profit. Modest profit means modest contribution room, no matter how much you'd like to save.

The Solo 401(k): more work, more room

A Solo 401(k) (for business owners with no employees other than a spouse) lets you contribute in two capacities. As the employee, you can defer up to $23,500 (2025), plus catch-ups if you're 50 or older — regardless of your profit percentage, as long as you earned at least that much. As the employer, you add the same ~20–25% of compensation the SEP allows. Same overall $70,000 ceiling, but the employee deferral lets you reach it — or reach a meaningful number — at far lower income.

The other Solo 401(k) advantages

• Roth option: most Solo 401(k) providers offer Roth employee deferrals. SEP-IRAs are traditional pre-tax only at most brokerages.
• Backdoor Roth compatibility: SEP-IRA balances count in the pro-rata rule and can wreck a backdoor Roth. Solo 401(k) balances don't — and a Solo 401(k) can even accept rollovers of old IRA money to clear the way.
• Loans: many Solo 401(k) plans permit borrowing up to $50,000 or half the balance. IRAs never allow loans.
• Higher effective limits at low-to-middle incomes, as the example shows.

Where the SEP still wins

• Deadline flexibility: you can open a SEP after year-end and still deduct for the prior year. A Solo 401(k) must generally exist by December 31 for employee deferrals (recent law loosened this somewhat for sole proprietors, but don't cut it close).
• Zero paperwork forever: Solo 401(k)s require IRS Form 5500-EZ annually once assets pass $250,000. Forgetting it carries steep penalties. SEPs never file.
• You have (or will hire) employees: SEPs cover employees with equal percentage contributions — simple, if expensive. A Solo 401(k) simply isn't allowed once you have non-spouse employees; you'd need a full 401(k) plan.
• Side-hustlers already maxing a day-job 401(k): the $23,500 employee deferral is shared across all your 401(k)s, so if it's used up at work, the Solo's headline advantage shrinks and a SEP's simplicity looks better.

How to set one up

1. Get an EIN from the IRS (free, takes minutes online) — Solo 401(k) providers require one.
2. Open the plan at a major brokerage (Fidelity, Schwab, E*TRADE all offer free Solo 401(k)s) before December 31.
3. Calculate your allowed contribution at tax time — or have your CPA do it; the self-employment math has traps.
4. Automate monthly contributions rather than scrambling in April.
5. Calendar-remind yourself about Form 5500-EZ for the year your balance crosses $250,000.

The contribution gap at every income level

The table makes the pattern obvious: the Solo 401(k)'s edge is a constant $23,500 (the employee deferral) at every income level until both accounts hit the overall cap, which happens only above roughly $330,000 of net profit. Below that ceiling — which is to say, for the vast majority of freelancers and small business owners — the Solo 401(k) simply shelters more. The two accounts are only true equals for very high earners, and even then the Solo's Roth option and backdoor-Roth compatibility break the tie.

The mistakes that cost self-employed savers real money

• Waiting until 'the business is more stable.' A freelancer earning $80,000 who defers the decision five years forfeits roughly $150,000+ of tax-advantaged space that never comes back — annual limits don't roll over.
• Confusing the deduction math: for sole proprietors the employer contribution is about 20% of net profit after the self-employment tax deduction, not a flat 25% of gross. Tax software or a CPA gets this right; napkins usually don't.
• Opening a SEP while doing backdoor Roths. The pro-rata rule pulls the SEP balance into every conversion's tax calculation — a five-figure surprise at filing time.
• Missing the December 31 deadline for a Solo 401(k) and then contributing nothing at all, when a SEP opened in March could still have captured the prior year.
• Forgetting the spouse: a spouse who legitimately works in the business can get their own employee deferral and employer contribution, potentially doubling the household's shelter.
• Filing nothing when the Solo 401(k) crosses $250,000 — the Form 5500-EZ penalty runs $250 per day, for a form that takes fifteen minutes.

One more planning note for side-hustlers: the employee deferral limit is per person, not per plan, but the employer limit is per unrelated business. Someone maxing a day-job 401(k) can still make employer-side contributions to a Solo 401(k) on freelance profit — roughly 20% of it — sheltering meaningful money even with the deferral slot used up. That's the configuration where the SEP and Solo genuinely tie, and simplicity can win.

The bottom line

Self-employment's quiet superpower is contribution room most W-2 employees can only envy. The Solo 401(k) is the stronger tool for nearly every solo business owner — more space at the same income, a Roth option, and no backdoor-Roth interference — while the SEP-IRA survives as the simple, last-minute alternative. The worst choice is the common one: earning self-employment income for years and sheltering none of it.