Solo 401(k) vs SEP IRA: Which Retirement Plan Is Right for Your Small Business?

Why Does This Choice Matter for a Self-Employed Business Owner?

If you run your own business — whether as a freelancer, an online seller, a real estate investor, an independent contractor, or the owner of an S corporation — you do not have an employer sponsoring a 401(k) plan on your behalf. That means building retirement savings is entirely your responsibility, and the tax code gives you a meaningful incentive to do it.

Contributions to a qualifying retirement plan may reduce your federal taxable income dollar for dollar, subject to applicable limits. For a business owner paying both income tax and self-employment tax, that reduction can translate into real savings at tax time. The two plans that come up most often for self-employed individuals are the Solo 401(k) — also called an Individual 401(k) or owner-only 401(k) — and the SEP IRA (Simplified Employee Pension Individual Retirement Account).

I have spent more than 15 years working with taxes, accounting, finance, and small business owners. I see this question come up constantly: which plan is better? The honest answer is that it depends on your specific situation, and getting it wrong can mean leaving a significant deduction on the table — or creating compliance problems you do not want.

What Is a Solo 401(k) and Who May Use One?

A Solo 401(k) is a traditional 401(k) plan designed for a business owner with no full-time W-2 employees other than the owner and the owner's spouse. It is available to sole proprietors, single-member LLC owners, partners in a partnership, and S corporation shareholder-employees — provided no eligible employees other than a spouse are covered under the plan.

What makes the Solo 401(k) unique is its two-part contribution structure:

• Employee elective deferrals: As the employee of your own business, you can contribute up to 100% of your compensation up to the annual deferral limit. For 2025, that limit is $23,500, with a catch-up contribution of an additional $7,500 for those age 50 or older. SECURE 2.0, which was enacted in December 2022, introduced an enhanced catch-up for individuals ages 60 through 63: for 2025, that enhanced catch-up is $11,250 instead of $7,500. The IRS typically announces updated limits for the following year in October or November, so verify current 2026 limits at IRS.gov before contributing.
• Employer profit-sharing contribution: In addition to the employee deferral, you can also make an employer profit-sharing contribution of up to 25% of your W-2 compensation (if you operate through an S corporation or C corporation) or approximately 20% of your net self-employment income after the deductible portion of self-employment tax is subtracted (for sole proprietors and single-member LLCs).

The combined limit for both contributions cannot exceed the annual additions limit under IRC Section 415(c), which for 2025 is $70,000 (or $77,500 including catch-up contributions for those age 50 or older, subject to applicable rules).

What Is a SEP IRA and Who May Use One?

A SEP IRA is a simplified employer-sponsored retirement arrangement that allows eligible business owners to make tax-deductible contributions to individual retirement accounts set up for themselves and, when applicable, for their employees. The SEP IRA is popular for its simplicity: there is no plan document to maintain beyond the IRS model form (Form 5305-SEP), no annual Form 5500 filing requirement below certain thresholds, and contributions can be made — and the plan can be opened — as late as the tax return due date including extensions.

For a self-employed individual, SEP IRA contributions are calculated as approximately 20% of net self-employment income after the deductible portion of self-employment tax (under the self-employed contribution rate formula, which produces an effective employer contribution rate of approximately 20% for sole proprietors). The exact calculation follows the IRS Worksheet in Publication 560. For S corporation employees, the contribution is 25% of W-2 compensation. The annual contribution limit for 2025 is the lesser of 25% of compensation or $70,000.

One critical difference: a SEP IRA does not allow employee deferrals. Every dollar you contribute goes in as an employer contribution, and you cannot make a separate Roth contribution or a catch-up contribution. The employer contribution percentage must also be uniform across all eligible employees.

How Do the Contribution Limits Compare Side by Side?

A Detailed Numerical Example: Which Plan Produces a Higher Deduction?

The following example is simplified for illustration only. Actual results depend on your specific facts, entity type, compensation, and applicable tax law. This example does not account for state taxes, payroll taxes, or all applicable limitations.

Scenario: Maria, sole proprietor, net self-employment profit of $120,000

Maria is a freelance graphic designer in Las Vegas who reports her business on Schedule C. Her net profit for 2025 is $120,000. She is 45 years old. She has no employees.

Step 1 — Calculate the deductible portion of self-employment tax:
Net SE income: $120,000
SE tax rate: 15.3% on net SE income up to $176,100 (2025 wage base) × 92.35% = approximately $16,961
Deductible half of SE tax: approximately $8,481

Step 2 — Net SE income for retirement contribution purposes:
$120,000 − $8,481 = $111,519

Under a SEP IRA (employer contribution only):
20% × $111,519 ≈ $22,304 maximum SEP IRA deduction

Under a Solo 401(k):
Employee deferral (2025 limit): $23,500
Employer profit-sharing: 20% × $111,519 ≈ $22,304
Combined: $23,500 + $22,304 = $45,804
(Well below the $70,000 ceiling, so the full amount may be deductible subject to net SE income.)

Maria's Solo 401(k) produces a maximum contribution of approximately $45,804, versus approximately $22,304 for a SEP IRA. The difference — roughly $23,500 — comes from the employee deferral that a SEP IRA does not offer. For a sole proprietor with Maria's income, the Solo 401(k) can allow a significantly larger deduction at lower income levels where the employer profit-sharing contribution alone would be modest.

At Higher Income Levels, Does the Gap Narrow?

Yes. As net self-employment income rises, the 20% employer profit-sharing contribution under either plan grows, and at a certain income level, the employer contribution alone reaches the $70,000 ceiling. At that point, the SEP IRA and the Solo 401(k) produce the same total employer contribution limit, though the Solo 401(k) still offers the additional employee deferral on top — which can push the total above $70,000 only up to the applicable overall annual additions limit.

For very high earners where the employer contribution alone maxes out the plan, the SEP IRA's simplicity may make it attractive. For moderate-income self-employed individuals, the Solo 401(k)'s employee deferral often produces a much larger deduction at the same income level.

What About S Corporation Owners and LLC Members?

If you operate through an S corporation and pay yourself a W-2 salary, the contribution calculations change. Your elective deferral as an employee is based on your W-2 wages, and the employer profit-sharing contribution from the S corporation is up to 25% of your W-2 compensation. S corporation owners who also have the corporation contribute to a SEP IRA or Solo 401(k) on their behalf can potentially maximize contributions, but the correct classification of compensation, the interaction with reasonable compensation requirements, and payroll tax treatment must all be handled properly.

LLC members who are treated as sole proprietors for tax purposes follow the sole proprietor calculation. Multi-member LLCs treated as partnerships follow partnership rules, which can be more complex. If you are unsure how your entity type affects the calculation, Elite Tax Consulting can work through the numbers specific to your situation.

How Does This Apply to Nevada Business Owners?

Nevada does not impose a personal state income tax, so contributions to a Solo 401(k) or SEP IRA do not produce a state income tax deduction at the Nevada level. However, the federal tax deduction still applies and can be substantial. Nevada business owners may still be subject to:

• Federal income taxes at ordinary income rates
• Self-employment taxes (15.3% on net SE income up to the annual wage base, 2.9% above it)
• The Modified Business Tax (MBT) on wages paid to employees, administered by the Nevada Department of Taxation
• Commerce Tax obligations for businesses with Nevada gross revenue above $4 million in a fiscal year
• Federal payroll taxes on W-2 wages paid through an S corporation or other entity

Retirement plan contributions reduce your federal taxable income. For a Nevada business owner subject only to federal taxes on ordinary income, maximizing your plan contribution is one of the most direct ways to reduce your current federal tax bill legally.

What Records and Documents Should You Keep?

• Plan adoption agreement — the legal document establishing the plan, obtained from your financial institution or plan provider
• Contribution records — bank statements, brokerage confirmations, or account statements showing the date and amount of each contribution
• Schedule C or Schedule K-1 — the tax forms showing your net self-employment income or partnership income that forms the basis for your contribution calculation
• W-2 forms — if you operate through an S corporation, your W-2 documents the compensation on which employer and employee contributions are based
• Form 5500-EZ filings — required for a Solo 401(k) when plan assets exceed $250,000 at the end of the plan year; keep copies of all prior filings
• IRS Form 5305-SEP — the model SEP agreement; keep a signed copy for each tax year the plan is in effect
• Calculation worksheets — retain any worksheets used to determine your maximum allowable contribution for each year

Common Mistakes That Can Cost You the Deduction

• Missing the Solo 401(k) plan setup deadline: Unlike a SEP IRA, a Solo 401(k) must be established by December 31 of the tax year for which you want to make contributions. If you wait until January or February to think about this, it may be too late for the prior year. (Note: SECURE 2.0 made a limited exception allowing new 401(k) plans to be adopted up to the tax return due date including extensions for tax years beginning after December 29, 2022, but verify current rules and consult a professional before relying on this provision.)
• Over-contributing: The total contributions across all plans you participate in — including any W-2 employment deferrals — must not exceed the applicable annual limits. If you also work a regular job with a 401(k), your elective deferrals across both plans combined are limited to the single annual deferral cap.
• Hiring employees without revisiting your plan: If you hire a full-time non-spouse employee who meets the eligibility requirements, you generally can no longer maintain a Solo 401(k). Failing to add eligible employees to a SEP IRA is also a compliance error.
• Not taking the deduction in the right place: Solo 401(k) and SEP IRA contributions for a sole proprietor reduce taxable income on Schedule 1, not on Schedule C. This means they do not reduce self-employment tax (though the deductible portion of SE tax is calculated first and affects the contribution limit). Misplacing the deduction on Schedule C results in an incorrectly calculated SE tax.
• Failing to file Form 5500-EZ: Solo 401(k) plans with more than $250,000 in assets at the end of the plan year must file Form 5500-EZ. The penalty for late filing can be significant.
• Using the wrong contribution rate for a sole proprietor: Many people mistakenly calculate SEP IRA contributions as 25% of net profit, but the correct self-employed rate is approximately 20% because the calculation accounts for the circular nature of the contribution itself.

What Should You Do Before Year End?

If you have not yet set up a retirement plan for your business, here is a practical framework for thinking through the decision:

1. Determine your entity type and compensation structure. Are you a sole proprietor on Schedule C, an S corporation shareholder paying yourself W-2 wages, or a partner in a multi-member LLC? The answer changes your calculation.
2. Evaluate whether you have or expect to hire eligible employees. If so, a Solo 401(k) may not be available to you.
3. Estimate your net self-employment income for the year. Run the contribution calculation under both plans to see which produces a larger deduction given your income level.
4. Check the Solo 401(k) setup deadline. If you want a Solo 401(k) for the current year, you generally need to establish it by December 31. Do not wait.
5. Consider your non-tax priorities. Do you want the ability to take a loan from your retirement account? A Solo 401(k) may permit this; a SEP IRA does not. Do you want Roth contribution options? Solo 401(k) may offer this; SEP IRA does not.
6. Consult a qualified tax professional before contributing. The interaction between entity type, compensation, SE tax, payroll taxes, and the applicable plan rules is complex enough that a planning conversation before year end is almost always worth it.

You can schedule a consultation here to go through your specific numbers and determine which plan makes sense for your business this year.

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