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

Last year, Rachel opened a SEP IRA for her freelance consulting business. Her accountant said it was simple and flexible. She was earning $120,000, and she assumed she was maximizing her retirement savings.

Rachel, 47, contributed $22,400 — about 20% of her adjusted self-employment income. She felt good about it. Then she met a colleague with the same income who had contributed $45,400 to a Solo 401(k).

She was stunned.

"I left $23,000 on the table," Rachel said. "That's $23,000 I could have sheltered from taxes. Over 15 years, that's hundreds of thousands in lost growth. Nobody told me the Solo 401(k) lets you make employee deferrals on top of employer contributions."

This is the reality of self-employed retirement planning. Both SEP IRAs and Solo 401(k)s offer high contribution limits and tax advantages — but they work very differently. The wrong choice at moderate income levels can cost you tens of thousands in missed savings.

How do they compare at a glance?

Before diving into details, here's the bottom line:

The numbers look similar at the top, but the paths to get there are completely different — and that difference matters enormously at moderate income levels.

When does a SEP IRA make sense?

SEP stands for Simplified Employee Pension. It's essentially a Traditional IRA with much higher contribution limits, funded entirely by employer contributions. The "simplified" part is real: you can set one up at any major brokerage in about thirty minutes, and there's no annual filing requirement.

The contribution math, however, is more complicated than it appears. You'll see "25% of compensation" advertised everywhere, but that 25% applies to W-2 employees. For self-employed individuals, the effective rate works out to approximately 20% of net self-employment income after adjustments for self-employment tax.

Picture David, a freelance consultant with $150,000 in net self-employment income. He starts with that $150,000, subtracts about $10,600 for half of his self-employment tax, and multiplies the remaining $139,400 by 20%. His maximum SEP contribution is $27,880 — not the $37,500 he might have expected from the "25%" marketing.

The SEP IRA's biggest advantages are simplicity and flexibility. You can contribute any amount up to your limit each year, adjust based on business performance, and fund the account all the way up to your tax filing deadline, including extensions. There's no Form 5500 to file, no plan document to maintain, and no catch-up contributions to track.

But the drawbacks are significant. There's no Roth option — every dollar goes in pre-tax. There are no employee deferrals, which means your contributions are capped at that 20% effective rate. And if you have employees, you must contribute the same percentage for them as you do for yourself, which can make the SEP prohibitively expensive for growing businesses.

Why can you contribute so much more to a Solo 401(k)?

This is the Solo 401(k)'s superpower: you can make both employee and employer contributions. It's like having two separate faucets filling the same retirement bucket.

The employee deferral is $23,000 in 2024, plus an additional $7,500 if you're 50 or older. On top of that, you can add employer profit-sharing contributions of up to 20% of your adjusted self-employment income. The combined total can reach $69,000 — or $76,500 with the catch-up.

Picture Marcus, age 55, with $100,000 in net self-employment income. With a Solo 401(k), he contributes $23,000 as an employee deferral, adds $7,500 for his catch-up, and then contributes another $18,600 as an employer contribution (20% of his adjusted income). His total is $49,100. With a SEP IRA, Marcus could only contribute that $18,600 employer portion — a difference of $30,500 every single year.

The Solo 401(k) also offers a Roth option for your employee deferrals. You can't make Roth employer contributions, but the ability to put $23,000 (or $30,500 with catch-up) into a Roth account each year is a significant advantage for tax diversification. And if you might need access to your retirement funds in an emergency, many Solo 401(k) plans allow loans up to $50,000.

The tradeoffs are more complexity and more deadlines. You'll need a plan document, potentially separate Traditional and Roth accounts, and Form 5500-EZ filing once your assets exceed $250,000. Most importantly, the plan must be established by December 31 of the tax year — you can't open one retroactively in April the way you can with a SEP.

What does this mean in real dollars?

Let's look at three freelancers with different incomes. Same year, same tax laws — very different outcomes depending on which plan they chose.

At $75,000 in net self-employment income, a SEP IRA allows roughly $13,950 (20% of adjusted income). A Solo 401(k) allows approximately $36,950 — the same $13,950 as an employer contribution, plus a full $23,000 employee deferral. The Solo 401(k) lets you save $23,000 more.

At $200,000 in income, the gap narrows but remains substantial. A SEP caps out around $37,200, while a Solo 401(k) reaches $60,200. That's still $23,000 in additional tax-advantaged savings.

At $400,000 in income, both plans hit the $69,000 maximum. At this level, the choice comes down to other factors: do you want the Roth option? Do you need catch-up contributions? Can you handle the extra paperwork?

Why does the Roth option matter so much?

Picture Elena, 42, earning $150,000 as a consultant. She's not sure whether tax rates will be higher or lower when she retires, so she hedges. She puts $23,000 into her Solo 401(k) as a Roth employee deferral — after-tax money that will grow and withdraw completely tax-free. Then she adds $20,000 as a Traditional employer contribution, getting a tax deduction today.

This gives her tax diversification — buckets of money taxed at different rates depending on what tax policy looks like in 25 years. The Roth portion grows tax-free, has no required minimum distributions during her lifetime (if rolled to a Roth IRA), and provides flexibility in retirement to manage her tax brackets year by year.

This strategy is impossible with a SEP IRA, which is Traditional-only. If you believe tax rates might rise, or you simply want optionality, the Solo 401(k)'s Roth feature is worth the extra setup complexity.

Which plan fits your situation?

The "best" plan depends on your specific circumstances. A SEP IRA makes sense when you want the simplest possible setup, have very high income approaching $300,000 or more, don't need Roth contributions, have employees you don't want to cover equally, or are setting up a plan after year-end.

A Solo 401(k) is the right choice when you want to maximize contributions at lower or moderate income, want the Roth option for tax diversification, might need a loan from retirement funds, are 50 or older and want catch-up contributions, or value flexibility over simplicity.

One timing issue catches people every year: if it's January and you're filing taxes for the previous year, you can still open a SEP IRA and fund it for that tax year. You cannot do this with a Solo 401(k) — that plan must have been established by December 31. If you're reading this after year-end and haven't set up a plan yet, the SEP is your only option for the prior year.

What about employees?

This is where the plans diverge completely. A Solo 401(k), by definition, is for businesses with no employees other than a spouse. The moment you hire your first W-2 employee, you must close the Solo 401(k) and establish a different retirement plan.

A SEP IRA can cover employees, but you must contribute the same percentage of compensation for all eligible employees as you contribute for yourself. If you put in 20% of your income, you owe 20% for each eligible employee. This can make SEP IRAs expensive for businesses with staff.

If you anticipate hiring, think carefully about which plan makes sense long-term. Starting with a Solo 401(k) for maximum contributions and then switching to a different plan when you hire is a valid strategy — just be prepared for the transition.

How do you set up each plan?

Setting up a SEP IRA is remarkably simple. Choose a provider like Vanguard, Fidelity, or Schwab, complete the one-page IRS Form 5305-SEP, open the account through an online application, and fund it by your tax filing deadline. The whole process takes about thirty minutes.

Setting up a Solo 401(k) requires a bit more work. You'll choose a provider (many brokerages offer free Solo 401(k) plans), establish a plan document that the provider typically supplies, open potentially separate Traditional and Roth accounts, obtain an EIN if you don't have one, and fund the account. Employee deferrals must be contributed by year-end; employer contributions can wait until your tax deadline. The setup takes one to two hours, plus ongoing administration.

The critical deadline: your Solo 401(k) plan must be established by December 31 of the tax year. You can fund it later, but the plan itself must exist before the year ends.

Can you have both plans?

Technically, you can maintain both a SEP IRA and a Solo 401(k), but combined contributions cannot exceed the total limits, and there's rarely a benefit to the complexity. You're usually better off picking one plan and maximizing it.

You can, however, contribute to both a SEP IRA (or Solo 401(k)) and a regular Traditional or Roth IRA. The SEP and Solo 401(k) limits ($69,000) are entirely separate from the IRA limits ($7,000, or $8,000 if you're 50+). If you have the cash flow, you can fund both.

What if things change?

Switching from a SEP IRA to a Solo 401(k) is straightforward. Open the Solo 401(k) before December 31, stop contributing to the SEP, and optionally roll your SEP IRA into the Solo 401(k) to simplify your accounts. Then begin making both employee and employer contributions.

Switching from a Solo 401(k) to a different plan — usually because you've hired employees — requires closing the Solo 401(k) and establishing a SIMPLE IRA, SEP IRA, or traditional 401(k) that can cover your staff.

Choose the right plan, maximize every dollar

SEP IRAs win on simplicity; Solo 401(k)s win on flexibility, contribution potential at moderate incomes, and Roth access. For most solo business owners earning under $200,000, the Solo 401(k) provides meaningful additional savings — don't leave money on the table like Rachel did. Whichever you choose, the best plan is the one you actually use.

Need help choosing and optimizing your self-employed retirement plan? Connect with a retirement advisor who specializes in small business retirement strategies.