Solo 401(k) vs SEP-IRA: Which Wins for Self-Employed?

Why this decision matters more than most people realize

If you're self-employed, two retirement accounts are designed for you: the Solo 401(k) and the SEP-IRA. Both let you save aggressively and reduce your taxable income. Both share the same $69,000 total contribution limit for 2024. And yet, for most self-employed people at typical income levels, one of them allows significantly larger contributions.

The choice between them is not complicated once you understand how the contribution limits work. Most people pick based on convenience or brand familiarity rather than math.

How each account works

A SEP-IRA works like a profit-sharing plan. Your business contributes up to 25% of your compensation, with a maximum of $69,000 for 2024. There is no separate employee contribution. It is simple to open, requires minimal paperwork, and can be funded up to your tax filing deadline including extensions.

A Solo 401(k) is a full 401(k) plan for a business with no employees other than the owner (and optionally the owner's spouse). It has two separate contribution buckets: an employee contribution from your wages, and an employer profit-sharing contribution from your business. The combination of both is what makes it powerful.

The contribution math: where Solo 401(k) usually wins

For 2024, a Solo 401(k) allows:

• Employee contribution: up to $23,000 (plus $7,500 catch-up if you're age 50 or older)
• Employer profit-sharing: up to 25% of W-2 compensation, or approximately 20% of net self-employment income after the SE tax deduction
• Combined total: $69,000 (or $76,500 with the catch-up)

A SEP-IRA allows only the employer-side contribution: 25% of compensation, or roughly 20% of net SE income, capped at $69,000. There is no employee contribution bucket.

The gap is the $23,000 employee contribution that the Solo 401(k) adds on top of the employer portion. At lower income levels where the employer portion alone is small, this difference is significant.

The Roth option: Solo 401(k) only

Solo 401(k) plans can include a Roth option, allowing after-tax employee contributions that grow tax-free and come out tax-free in retirement. SEP-IRAs are traditional only; there is no Roth SEP-IRA.

This matters if you expect to be in a higher tax bracket in retirement, or if you want to hedge against future tax rate increases. High earners who exceed the income limits for a regular Roth IRA can use the Solo 401(k) Roth option as a path to tax-free retirement savings.

Loans from a Solo 401(k)

Solo 401(k) plans can allow participant loans: up to the lesser of $50,000 or 50% of the account balance. This provides access to funds without triggering a tax event, as long as the loan is repaid on schedule. SEP-IRAs do not allow loans.

Setup requirements and deadlines

A SEP-IRA can be opened and funded as late as your tax return deadline, including extensions. For most sole proprietors, that means you can open and fund a SEP-IRA by October 15 of the following year and still count it for the prior tax year.

A Solo 401(k) must be established (plan documents signed) by December 31 of the tax year for contributions to count. You can fund it up to your filing deadline, but the plan must exist before year-end. If you're considering this in October, you still have time, but do not wait.

When SEP-IRA wins

• Your income is high enough that the 25% employer contribution alone approaches the $69,000 cap. At roughly $276,000 in net SE income, a SEP-IRA maxes out. The Solo 401(k) caps at the same total, so at that income level the advantage disappears.
• You have multiple self-employment businesses and want to combine employer contributions from each. SEP-IRA rules accommodate this more cleanly.
• You value simplicity and want to avoid the annual Form 5500-EZ filing that Solo 401(k) plans require once the balance exceeds $250,000.

Common mistakes

• Missing the December 31 Solo 401(k) establishment deadline. If you miss it, you default to a SEP-IRA and leave the employee contribution room on the table.
• Not using the catch-up contribution at age 50+. The additional $7,500 is an easy $7,500 more in tax-deferred savings with no additional complexity.
• Assuming both accounts allow the same total contribution at all income levels. Below roughly $200,000 in net SE income, the Solo 401(k) almost always allows significantly more.
• Hiring employees and forgetting to update the plan. Solo 401(k) eligibility requires no employees other than yourself and possibly your spouse. Hiring employees may require converting to a different plan type.

This article is for educational purposes only and does not constitute tax, legal, or financial advice. Consult a licensed CPA, tax attorney, or enrolled agent before implementing any strategy. Tax laws change and your specific circumstances matter.