Choosing between a solo 401(k) vs SEP IRA is one of the first real financial decisions a self-employed person faces once income becomes consistent. Both plans are straightforward to open, both allow far larger contributions than an IRA, and both reduce current taxable income. They are not, however, interchangeable. The right answer depends on how much you earn, how your business is structured, whether you intend to hire anyone, and how much administrative work you are willing to accept.
We work with a number of consultants, contractors, tutors, therapists, and small practice owners in the Sacramento region, and this question comes up constantly. Below is a plain comparison using current 2026 figures.
Solo 401(k) vs SEP IRA: the structural difference
A SEP IRA accepts only employer contributions. There is no salary deferral. Whatever goes in is an employer contribution from the business, capped at 25 percent of compensation.
A solo 401(k), which the IRS calls a one-participant 401(k), has two contribution sources. You contribute as the employee through salary deferrals, and you contribute again as the employer through profit sharing. That second bucket is the reason a solo 401(k) usually wins at moderate income levels.
What you can contribute in 2026
The IRS raised its retirement plan limits for 2026. The employee deferral limit is $24,500, up from $23,500 in 2025. The catch-up contribution for those age 50 and older is $8,000. Participants who turn 60, 61, 62, or 63 during the year may instead use the higher catch-up of $11,250.
The overall limit on total contributions to a defined contribution plan is $72,000 for 2026, before any catch-up. That same $72,000 figure caps a SEP IRA. The compensation that may be counted is limited to $360,000.
The math that surprises people
To reach the $72,000 ceiling through a SEP IRA alone, an unincorporated business owner needs roughly $360,000 of net self-employment income, because the effective contribution rate for a sole proprietor works out to about 20 percent of net earnings rather than 25 percent of W-2 pay. The details are in IRS Publication 560.
A solo 401(k) gets there much faster. A sole proprietor with $100,000 of net earnings could defer $24,500 as the employee and add roughly $18,600 as the employer, for something near $43,100. The same person with a SEP IRA would be limited to the employer piece alone, roughly $18,600. For anyone earning under about $200,000, that gap is the entire argument.
Deadlines, and the rule that changed for sole proprietors
A SEP IRA may be established and funded as late as the tax filing deadline including extensions. That flexibility is real, and it is why accountants often suggest a SEP in March when a client is looking for a deduction after the fact.
Solo 401(k) plans were historically less forgiving, because salary deferrals require a plan to exist. Section 317 of the SECURE 2.0 Act changed this for a narrow but important group. A sole proprietor with no employees who is adopting a first-year plan may establish it by the tax return due date, not including extensions, and make retroactive employee deferrals for the prior year. For a calendar year filer, that means April 15. This provision applies only in the plan’s first year, so it is a one-time opportunity rather than an ongoing habit.
Where the two plans diverge
| Feature | Solo 401(k) | SEP IRA |
|---|---|---|
| Employee deferrals | Yes, up to $24,500 | No |
| Age 50 catch-up | Yes, $8,000 | No |
| Roth contributions | Generally available | Not available |
| Plan loans | Permitted if the plan allows | Not permitted |
| Setup complexity | Moderate, requires a plan document | Low |
| Annual filing | Form 5500-EZ once assets exceed $250,000 | None |
| If you hire employees | Plan must be amended, testing applies | Same percentage required for all eligible employees |
The final row deserves emphasis. A SEP IRA requires the business to contribute the same percentage of compensation for every eligible employee. If you contribute 20 percent for yourself, you contribute 20 percent for them. For a business planning to add staff, that becomes expensive quickly.
A note on the 2026 Roth catch-up rule
Beginning in 2026, catch-up contributions must be made on a Roth basis if the participant’s prior-year FICA wages from the plan sponsor exceeded $150,000. Treasury and the IRS finalized these rules in regulations issued in late 2025.
There is a nuance worth knowing. The requirement keys off FICA wages. A sole proprietor with self-employment income and no W-2 wages from the sponsoring business does not have FICA wages for this purpose, and so is not pushed into a Roth catch-up. An S corporation owner who pays himself or herself a W-2 salary above the threshold is a different matter. This is a good example of why entity structure and plan design should be considered together rather than separately.
Which one fits your situation
Open the scenario that most resembles yours.
Side income of $30,000 from consulting, with a full-time job that already has a 401(k)
Full-time self-employed, net earnings around $90,000, no employees
Net earnings above $350,000, no employees
Planning to hire an employee within the next two years
Mistakes we see most often
- Assuming the employee deferral limit resets per job. It does not. The $24,500 limit is per person across all employer plans.
- Forgetting Form 5500-EZ once solo 401(k) assets pass $250,000. The penalties for late filing are meaningful and entirely avoidable.
- Opening a SEP in a year with unusually low income, then discovering the contribution was smaller than expected because the calculation runs off net earnings after the self-employment tax deduction.
- Choosing a plan without considering entity structure. The S corporation election, reasonable compensation, and plan contributions are one decision, not three.
If you would like a second opinion before you commit, the SEC’s investor education site is a reasonable starting point for the mechanics, though it will not tell you which plan suits your particular numbers.
The solo 401(k) vs SEP IRA question is worth getting right early, because the difference compounds for decades. If you are self-employed in the Sacramento area and want to talk through which structure fits your income and your plans for the business, we invite you to schedule a free 30-minute call. There is no cost and no obligation.
Schedule a free 30-minute call
Rooney Wealth Management LLC is an investment adviser registered with the state of California. This article is for educational purposes only and is not tax, legal, or investment advice. Please consult your tax or financial professional regarding your specific situation.
