Self-Employed Retirement Plans: SEP-IRA vs. Solo 401k Coverage Options and Limits

Why Self-Employed Retirement Plans Matter

When you're self-employed, you don't have an employer 401k match. But you CAN contribute much more to retirement than employees.

The advantage: As self-employed, you're both employee and employer. You can contribute up to ~25% of net self-employment income—often $20,000–$70,000/year—and deduct it from income taxes AND self-employment taxes.

This is the fastest way to reduce self-employment tax and build retirement savings simultaneously.

SEP-IRA (Simplified Employee Pension)

What it is: An individual retirement account for self-employed people. Simplified means minimal paperwork.

Setup:

• Open with any brokerage (Vanguard, Fidelity, etc.)
• Takes 30 minutes
• No annual filing (very simple)
• Cost: $0 (brokerage account opening is free)

Contribution limits: Up to 25% of net self-employment income, capped at $69,000/year (2024).

Calculation: Contribution limit = Net self-employment income × 25%

Example: $100,000 profit

• Self-employment income (after SE tax deduction): $100,000 × 92.35% = $92,350
• SEP-IRA contribution: $92,350 × 20% = $18,470

Wait, I said 25% but got 20%. Here's why: The 25% is of W-2 wages; for self-employed, it's actually 20% of net SE income after the SE tax deduction.

Use this formula: Contribution = (Net profit × 0.9235 × 0.20) ÷ (1 - (0.1413 × 0.9235))

Or use the IRS worksheet. Or use tax software.

Simpler: Contribution ≈ Net profit × 18.5% to 20% (varies slightly by income)

Example calculations:

• $50,000 profit: ~$10,000 SEP-IRA contribution
• $100,000 profit: ~$18,500 SEP-IRA contribution
• $200,000 profit: ~$37,000 SEP-IRA contribution
• $300,000 profit: ~$55,500 SEP-IRA contribution
• $400,000 profit: ~$69,000 SEP-IRA (capped)

Tax savings: SEP-IRA contributions reduce:

• Income tax: $18,500 × 24% = $4,440 saved
• Self-employment tax: $18,500 × 15.3% = $2,831 saved
• Total tax savings: $7,271/year

Investment options: You choose where the money goes (stocks, bonds, index funds, CDs, etc.). Self-directed.

Catch-up contributions (age 50+): Standard SEP-IRA doesn't have catch-up contributions (you can just contribute more based on higher income).

Withdrawals: Traditional SEP-IRA: Withdrawals are taxed as ordinary income. Penalty if withdrawn before 59.5 (10% penalty + income tax).

Best for:

• Income <$200,000
• Self-employed solo (no employees)
• Want simplicity
• Want tax deduction and self-employment tax savings

Pros:

• Simple to set up (30 minutes)
• No annual filing
• High contribution limits
• Significant tax savings
• Self-directed investments

Cons:

• Lower limits than Solo 401k (if income >$200k)
• Can't do Roth conversions (traditional only)
• If you hire employees, must contribute for them too (can get complicated)

Solo 401k (Self-Employed 401k)

What it is: A 401k plan designed for self-employed people with no employees. More complex than SEP but higher contribution limits.

Setup:

• Open with a brokerage or specialized provider (Fidelity, Schwab, etc.)
• Complete setup form and plan document
• Takes 1–2 hours
• Annual Form 5500-N filing (if over $250k in assets)
• Cost: $0–$100 setup, $0–$50/year filing

Contribution limits: You contribute as both employee and employer:

• Employee deferral: Up to $23,500/year (2024)
• Employer contribution: Up to 20% of net self-employment income
• Total: ~$69,000/year for most people, higher for high earners

Example: $100,000 profit

• Employee deferral: $23,500
• Employer contribution: $100,000 × 20% = $20,000
• Total: $43,500

Example: $300,000 profit

• Employee deferral: $23,500
• Employer contribution: $300,000 × 20% = $60,000
• Total: $83,500

Comparison to SEP-IRA:

• SEP-IRA on $300k profit: $55,500
• Solo 401k on $300k profit: $83,500
• Difference: $28,000 (Solo 401k is better for high earners)

Catch-up contributions (age 50+):

• Solo 401k: Add $8,000/year
• SEP-IRA: No catch-up (but you can contribute more based on higher income)

Roth option: Solo 401k can have Roth deferrals (post-tax contributions grow tax-free). SEP-IRA is traditional only.

Investment options: You can self-direct or choose from brokerage offerings. More flexibility than some plans.

Loan feature: Solo 401k allows loans against the balance (up to 50% or $50,000). SEP-IRA doesn't.

Best for:

• Income >$150,000
• Want maximum contribution room
• Might want Roth conversion strategy
• Might need to borrow against retirement funds

Pros:

• Higher contribution limits (for high earners)
• Roth option available
• Can borrow against balance
• Catch-up contributions

Cons:

• More complex setup
• Annual Form 5500-N filing (if over $250k assets)
• Can't have employees ("Solo" means no employees; if you hire, you need full 401k)

Choosing Between SEP-IRA and Solo 401k

Use SEP-IRA if:

• Income <$150,000
• Want simplicity
• Don't need Roth option or loans
• Don't want annual filings

Use Solo 401k if:

• Income >$150,000 and want to maximize contributions
• Want Roth option
• Might need to borrow against retirement savings
• Don't mind annual Form 5500-N filing
• Plan ahead: Solo 401k must be opened by Dec 31 of the tax year (SEP-IRA can be opened until tax filing deadline, typically April 15)

Worked Example: Tax Savings from Retirement Contributions

Scenario: $120,000 self-employed profit, 32-year-old, 24% tax bracket, 15.3% SE tax rate

Year 1: No retirement contribution

• Net profit: $120,000
• SE tax (15.3% on 92.35%): $17,058
• Income tax (24% on remaining): $24,000
• Taxes owed: $41,058
• After-tax income: $78,942

Year 2: $20,000 SEP-IRA contribution

• Net profit: $120,000
• SEP-IRA contribution: $20,000
• Taxable income after SEP: $100,000
• SE tax (15.3% on 92.35%): $14,248 (slightly lower because contribution reduced SE base)
• Income tax (24% on $100,000): $24,000
• Taxes owed: $38,248
• After-tax income: $81,752

Difference: $2,810 more take-home (Year 2 vs Year 1)

But you've also put $20,000 into retirement savings. Net effect:

• Tax savings: $2,810
• Retirement savings: $20,000
• Total benefit: $22,810 for a $20,000 contribution

This is why retirement contributions are powerful for self-employed.

Catch-Up Contributions: Getting Serious at 50+

If you're 50+, you can contribute more:

SEP-IRA:

• Standard limit: ~20% of net SE income
• No official catch-up, but you can contribute based on higher assumed income
• Effectively: No catch-up (you just contribute more if you have more income)

Solo 401k:

• Standard limit: $23,500 employee + employer portion
• Catch-up: $8,000 additional (for age 50+)
• Total: $31,500+ employee deferral + employer portion

Example: Age 52 with $200,000 profit

SEP-IRA:

• Contribution: $200,000 × 20% = $40,000
• No additional catch-up

Solo 401k:

• Employee deferral: $23,500 + $8,000 catch-up = $31,500
• Employer: $200,000 × 20% = $40,000
• Total: $71,500

Solo 401k advantage: $31,500 more (nearly 2× the SEP limit)

If you're 50+ and late to saving for retirement, Solo 401k is significantly better.

Backdoor Roth and Self-Employed Retirement Plans

Advanced strategy: Use Solo 401k for backdoor Roth conversions.

With a SEP-IRA, you have limited Roth conversion options (pro-rata rule complicates it).

With a Solo 401k, you can contribute to a Roth portion, which grows tax-free. This is especially valuable for high earners who want tax-free growth.

Not worth deep-diving here, but: If retirement strategy is important to you, Solo 401k's Roth option is a big advantage.

Action Items: Set Up Self-Employed Retirement Plan

1. Estimate current and projected profit: Determines which plan is better
2. If profit <$150k and want simplicity: Open SEP-IRA
   • Takes 30 minutes with any brokerage
   • Contribute before April 15 (tax filing deadline) of next year
3. If profit >$150k or want max contribution: Open Solo 401k
   • Takes 1–2 hours
   • Must open by December 31 of the tax year
4. Calculate contribution amount: Use IRS worksheet or tax software
5. Make the contribution: Before tax filing deadline
6. Invest the funds: Choose low-cost index funds
7. Repeat annually: Each year, contribute the maximum allowed

Example contribution schedule:

• Year 1: $15,000 SEP-IRA
• Year 2: $18,500 SEP-IRA
• Year 3: $22,000 SEP-IRA
• Year 10: $40,000+ SEP-IRA
• Year 20: $450,000+ saved (compounded at 7% growth)

Retirement contributions are the fastest way to reduce self-employment tax AND build retirement savings. Start now.