With $60,000 in net self-employment profit, a SEP-IRA shelters roughly $11,100 for the year. A Solo 401(k) can shelter up to $34,600 at that income. That is a gap of more than $23,000 in pre-tax retirement contributions.
Both plans are legitimate, widely available, and tax-advantaged. Their contribution formulas differ, though. At lower income levels, the Solo 401(k) advantage is large enough that defaulting to a SEP-IRA could leave substantial tax savings unused.
How SEP-IRAs Work
A SEP-IRA, or Simplified Employee Pension Individual Retirement Account, receives employer contributions only. As a self-employed person, you act as both employee and employer, making these contributions as the employer.
You can contribute 25% of net self-employment compensation, meaning net profit minus the deductible share of self-employment tax, up to the IRS dollar cap. For 2025, that cap was $70,000. Your contribution cannot exceed either limit.
Setup is straightforward. Most brokerages let you open a SEP-IRA in under an hour using one form, IRS Form 5305-SEP. There are no annual filings beyond claiming the deduction on your tax return. Contributions may be made by your filing deadline, including extensions, so an extension gives you until October 15 of the following year.
How Solo 401(k)s Work
A Solo 401(k) is for self-employed people and business owners with no full-time employees besides a spouse. It follows the traditional 401(k) structure, with two ways to contribute.
One is the employee elective deferral. You may contribute 100% of net self-employment compensation, or the IRS annual elective deferral limit, whichever is lower. For 2025, that limit was $23,500. This is why the Solo 401(k) works well at lower incomes: once net SE compensation reaches $23,500, you can defer the full amount, regardless of the 25% calculation.
The other is an employer profit-sharing contribution. Acting as employer, you may add up to 25% of net SE compensation beyond the elective deferral, subject to the annual overall limit, also $70,000 for 2025 before catch-up contributions.
Solo 401(k) contributions cannot exceed the annual overall limit. The elective deferral means you reach that ceiling at a much lower income than with a SEP-IRA.
Contribution Math at Three Income Levels
Here is the comparison at three net profit levels, using approximate 2025 figures. In each example, net SE compensation reflects a deduction for half of self-employment tax.
$50,000 in net profit, net SE compensation approximately $46,500:
- SEP-IRA: 25% x $46,500 = $11,625
- Solo 401(k): $23,500 elective deferral + $11,625 employer sharing = $35,125
$100,000 in net profit, net SE compensation approximately $92,700:
- SEP-IRA: 25% x $92,700 = $23,175
- Solo 401(k): $23,500 elective deferral + $23,175 employer = $46,675
$200,000 in net profit, net SE compensation approximately $186,000:
- SEP-IRA: 25% x $186,000 = $46,500
- Solo 401(k): $23,500 elective deferral + $46,500 employer = $70,000, overall limit
The difference shrinks as income grows. Above roughly $230,000 in net profit, both plans reach the same dollar cap, making the SEP-IRA equally effective with less administration.
Catch-Up Contributions Over 50
At age 50 or older, a Solo 401(k) permits catch-up contributions on employee deferrals. For 2025, the standard catch-up was $7,500, raising the elective deferral ceiling to $31,000. Under SECURE 2.0, ages 60 to 63 receive $11,250 of extra room instead of $7,500, starting in 2025.
SEP-IRAs have no catch-up contributions. For founders over 50 seeking faster retirement savings in profitable years, a Solo 401(k) offers a meaningfully higher ceiling.
Setup and Ongoing Administration
This is the SEP-IRA's clear advantage. Opening one generally takes an IRS form and a brokerage account. There are no annual IRS filings or additional plan documents after setup, and no establishment deadline. You can open it by your filing deadline.
A Solo 401(k) needs a plan document, usually supplied by the brokerage in a standard package. It must be established by December 31 of the year for which you want contributions, so you cannot open one retroactively in April as you can with a SEP-IRA. Plans above $250,000 in assets must file IRS Form 5500-EZ annually.
The brokerage account is similar either way. Most major brokerages offer Solo 401(k) plans at no extra cost. The added administration is real but manageable: a 20-minute setup in November is the main extra step compared with a SEP-IRA.
The Hiring Threshold That Changes Everything
A Solo 401(k) remains available only while you have no full-time W-2 employees other than a spouse. If your first employee works 1,000 or more hours per year, you can no longer contribute to the Solo 401(k) as of that year. You would need to move its assets to another plan type or an IRA.
If you expect to hire within one to two years, opening a Solo 401(k) now requires a transition plan. A SEP-IRA can cover employees later. Once eligible employees join, you must contribute for them at the same percentage you contribute for yourself.
That does not make the SEP-IRA the right choice for every pre-hire founder. At current income levels, the Solo 401(k) offers a real tax advantage for most founders. Still, active recruiting makes the Solo 401(k) exit worth considering.
For most solo founders and one-person LLCs without imminent hiring plans, the Solo 401(k) allows significantly larger pre-tax contributions, especially below $150,000 in income. Run the numbers using projected profit before the December 31 establishment deadline each year.
The contribution limits, dollar caps, and catch-up amounts here follow 2025 IRS guidelines and may change later. Check current limits at IRS.gov or with your CPA before contributing. This article provides general information, not personalized financial or tax advice.