Working for yourself means no employer retirement plan, but the tax code offers self-employed savers powerful alternatives. The two most popular are the SEP-IRA and the solo 401(k), each allowing far larger contributions than a standard IRA. They suit different situations, and the right choice can mean thousands of extra dollars saved each year. This guide compares how they work so you can pick the better fit.

How a SEP-IRA works

A SEP-IRA is funded entirely by employer contributions, which for a self-employed person means contributions from the business to yourself. You can contribute up to 25 percent of compensation, which works out to roughly 20 percent of net self-employment income after the self-employment tax adjustment. It is simple to open and has minimal paperwork, with no annual filing for most solo owners. Its appeal is ease, but at lower income levels it caps out sooner than the alternative.

How a solo 401(k) works

A solo 401(k) lets you contribute in two capacities: as an employee and as the employer. The employee portion is an elective deferral up to the annual limit, plus a catch-up amount if you are 50 or older, and the employer portion adds up to about 20 percent of net self-employment income. Because the employee deferral is a flat dollar amount rather than a percentage, you can save far more at modest income levels. Many solo 401(k) plans also offer a Roth option and the ability to borrow from the balance.

The contribution comparison

At high income, both plans reach a similar overall cap because total contributions are limited to the same annual maximum. At lower and middle income, the solo 401(k) wins because its employee deferral lets you contribute a large fixed amount before the percentage-based employer piece even applies. Someone earning 60,000 dollars can typically shelter much more in a solo 401(k) than in a SEP-IRA. This gap is the single biggest reason to prefer the solo 401(k) when eligible.

Choosing between them

Choose a SEP-IRA when you value simplicity, have very high income where the plans converge, or want the easiest possible setup. Choose a solo 401(k) when you want to maximize contributions at moderate income, want a Roth option, or want the loan feature. Note that a solo 401(k) is only for a business with no employees other than a spouse, and it requires a plan document and, once large, an annual information return. Both must generally be established and funded within tax deadlines, so plan ahead.

A freelancer nets 60,000 dollars. A SEP-IRA might allow roughly 11,000 dollars, about 20 percent of net earnings. A solo 401(k) lets her add a large employee deferral on top of that same employer-style contribution, potentially sheltering far more of the 60,000 dollars.

Key takeaways

  • A SEP-IRA is funded by employer contributions up to about 20 percent of net self-employment income.
  • A solo 401(k) adds an employee deferral, allowing bigger contributions at lower income.
  • At very high income the two plans reach a similar overall cap.
  • Solo 401(k)s often add a Roth option and a loan feature that SEP-IRAs lack.

Common mistakes

FAQ

Can I have employees and still use a solo 401(k)?

No. A solo 401(k) is only for a business with no employees other than the owner and a spouse; hiring staff requires a different plan.

Which plan lets me save more on a modest income?

The solo 401(k), because its flat employee deferral lets you contribute a large amount before the percentage-based employer contribution is added.