Solo 401(k)s and SEP IRAs for Self-Employed Investors

Self-employment offers many freedoms, but retirement saving is not one of them - you must build your own pension. The good news: the tax code gives self-employed investors access to the same contribution limits as large corporations. The key question is which vehicle: Solo 401(k) or SEP IRA? For most freelancers and consultants earning under 280,000, the Solo 401(k) allows significantly higher contributions (Fidelity, 2024).

The durable lesson: At 50,000 in self-employment income, a Solo 401(k) lets you contribute 32,793 vs. only 11,617 in a SEP IRA - a 21,176 difference in tax-advantaged savings. The math favors Solo 401(k) until income reaches roughly 280,000.

2025 Contribution Limits

Solo 401(k):

• Employee deferral: 23,500 (same as any 401k)
• Employer profit sharing: 20% of net self-employment income (after SE tax deduction)
• Age 50+ catch-up: 7,500 (or 11,250 for ages 60-63)
• Combined maximum: 70,000 (or more with catch-ups)

SEP IRA:

• Employer contribution only: 25% of net SE income (no employee deferral)
• Maximum: 70,000
• No catch-up contributions
• Minimum income for max: ~350,000 to reach 70,000

The point is: Solo 401(k) has two buckets (employee deferral + profit sharing). SEP IRA has one bucket (employer contribution only). This makes Solo 401(k) far superior at lower income levels.

Head-to-Head Comparison

Scenario 1: 50,000 Net Self-Employment Income

Calculating net SE earnings:

• Gross income: 50,000
• SE tax deduction: 3,533 (half of 15.3% SE tax)
• Adjusted net income: 46,467

Solo 401(k):

• Employee deferral: 23,500
• Employer profit sharing: 46,467 x 20% = 9,293
• Total contribution: 32,793

SEP IRA:

• Employer contribution: 46,467 x 25% = 11,617

Solo 401(k) advantage: 21,176 more in tax-advantaged savings.

Scenario 2: 100,000 Net SE Income, Age 52

Adjusted net income: 92,935 (after SE tax deduction)

Solo 401(k):

• Employee deferral: 23,500
• Age 50+ catch-up: 7,500
• Employer profit sharing: 92,935 x 20% = 18,587
• Total contribution: 49,587

SEP IRA:

• Employer contribution: 92,935 x 25% = 23,234

Solo 401(k) advantage: 26,353 more.

Breakeven Point: ~280,000 Net SE Income

At approximately 280,000 in net SE income, both plans can reach the 70,000 maximum. Above this income level, the SEP IRA is simpler with the same contribution ceiling.

Key Differences Beyond Contribution Limits

Roth Option:

• Solo 401(k): Available - can contribute employee deferral as Roth
• SEP IRA: Not available - all contributions are pre-tax only

Loans:

• Solo 401(k): Permitted if plan documents allow (up to 50,000 or 50%)
• SEP IRA: Not permitted - cannot borrow from SEP

Administrative Requirements:

• Solo 401(k): Must establish by December 31 for employee deferrals; Form 5500-EZ required when assets exceed 250,000
• SEP IRA: Can establish until tax filing deadline (including extensions); no annual filing requirements

Employees:

• Solo 401(k): Only for self-employed with no employees (spouse can participate)
• SEP IRA: Can have employees, but must contribute same percentage for all eligible employees

Why this matters: If you plan to hire employees, SEP IRA may be more practical - or you need a traditional 401(k) plan.

Establishment and Funding Deadlines

Solo 401(k):

• Plan establishment: December 31 of tax year (for employee deferrals)
• Employee deferral deadline: December 31 of tax year
• Employer contribution deadline: Tax filing deadline plus extensions (October 15 for calendar year)

SEP IRA:

• Establishment AND contribution deadline: Tax filing deadline plus extensions
• Advantage: Can establish and fund a SEP retroactively for the prior year until October 15

The practical point: If you are past December 31 and want to save for the prior year, SEP IRA is your only option.

Special Strategies

Mega Backdoor Roth (Solo 401(k) only): If your plan documents allow after-tax contributions:

• Contribute 23,500 pre-tax or Roth
• Contribute additional after-tax up to 70,000 combined limit
• Convert after-tax contributions to Roth

Example: 23,500 employee deferral + 46,500 after-tax = 70,000. Convert the 46,500 to Roth.

Side Business Strategy: If you have W-2 employment with 401(k) PLUS self-employment income:

• Employee deferral limit is shared: 23,500 total across all plans
• Employer contributions are separate: 25% from each employer

Example: Max 23,500 to W-2 employer 401(k), contribute 20% of side business income as employer profit sharing to Solo 401(k).

Spouse Employment: If your spouse works in the business:

• Solo 401(k): Spouse gets own 23,500 deferral + catch-up + profit sharing
• Combined household: Potentially 140,000+ per year in tax-advantaged savings

Decision Framework

Choose Solo 401(k) when:

• Net SE income under 280,000 (higher contributions)
• You want Roth contribution option
• You want ability to borrow from plan
• Only yourself and/or spouse as employees
• You can handle setup paperwork and Form 5500-EZ when over 250K

Choose SEP IRA when:

• Net SE income over 280,000 (both max at 70K, SEP simpler)
• You have or plan to have employees
• You want simplest possible administration
• You do not need Roth or loan features
• You are past December 31 and need to establish for prior year

Common Mistakes

Missing Solo 401(k) establishment deadline Must establish by December 31 for employee deferrals. If you miss it, you lose the 23,500 deferral for that year. SEP can still be established until filing deadline.

Using SEP when income is low At 50,000 income, SEP allows ~11,600 vs. Solo 401(k) ~32,800. That is 21,200 in lost tax-advantaged space.

Hiring W-2 employees while having Solo 401(k) Plan no longer qualifies as Solo - must convert to regular 401(k) or terminate.

Forgetting Form 5500-EZ Required when Solo 401(k) assets exceed 250,000. Due July 31 (can extend to October 15). IRS penalties for late/missing filing.

Checklist

Before choosing a plan:

• Calculate net SE income after SE tax deduction
• Compare Solo 401(k) vs. SEP contribution amounts for your income
• Consider whether you need Roth option or loan provisions
• Confirm you have no employees (for Solo 401(k) eligibility)
• Set calendar reminders for establishment and contribution deadlines
• If Solo 401(k), set reminder for Form 5500-EZ when assets approach 250K

References

• IRS Publication 560 (2024). Retirement Plans for Small Business.
• Bureau of Labor Statistics (2024). Self-Employment Trends.
• Fidelity (2024). Self-Employed Retirement Savings Report.