Business owners have access to retirement accounts that most employees can only envy. The contribution limits are higher, the flexibility is greater, and the tax benefits are substantial. But the options can also be confusing, and the wrong choice costs you both in retirement savings and current-year taxes.
This article breaks down the two most common retirement account types for self-employed individuals and small business owners — the SEP-IRA and the Solo 401(k) — including when each one makes sense and when each one doesn’t.
The SEP-IRA: Simple and Powerful
The SEP-IRA (Simplified Employee Pension) is one of the simplest retirement accounts available. You can open one through almost any brokerage in minutes, there’s minimal administration, and it allows contributions up to 25% of net self-employment income (or 25% of W-2 compensation if you operate as an S-Corp), up to a maximum of $72,000 for 2026 (verify current limits with the IRS, as these adjust annually).
The simplicity is the main appeal. There are no annual filing requirements, no plan documents to maintain beyond the basic adoption agreement, and contributions can be made up until your tax filing deadline including extensions (as late as October 15 for most business owners).
Limitations of the SEP-IRA: The 25% contribution limit is based on compensation, not a flat dollar amount, which means you need substantial income to reach the maximum contribution. On $100,000 of net self-employment income, you can contribute roughly $18,587 (because SE tax reduces net earnings used in the calculation). The SEP also doesn’t allow Roth contributions — everything goes in pre-tax. And if you have employees, you’re required to contribute the same percentage of their compensation as you do your own, which makes the SEP expensive if you have staff.
The Solo 401(k): More Powerful, Slightly More Complex
The Solo 401(k) — also called an Individual 401(k) or Self-Employed 401(k) — is available to self-employed individuals and business owners with no full-time W-2 employees other than a spouse. It offers higher effective contribution limits for lower income levels and adds features the SEP doesn’t have.
How contributions work: a Solo 401(k) accepts two types of contributions:
Employee contributions (elective deferrals): Up to $24,500 in 2026 (If you are age 50-59 or 64+, you can add an extra $8,000 (Total: $32,500). If you are age 60-63, you are eligible for an extended catch-up of $11,250 (Total: $35,750). This is a flat amount regardless of income. If you net $50,000 from your business, you can still contribute $24,500 as an employee deferral.
Employer contributions (profit sharing): Up to 25% of W-2 compensation (if S-Corp) or approximately 20% of net self-employment income. This is in addition to the employee deferral.
Combined, total contributions can reach the same $72,000 maximum (or more with catch-ups), but the Solo 401(k) reaches that ceiling at a much lower income level because of the flat employee deferral.
Additional features: Solo 401(k) plans can offer Roth contributions (after-tax money that grows tax-free), loan provisions, and in some cases access to alternative investments. These aren’t available in a SEP-IRA.
Limitation: Solo 401(k) plans require an EIN, a plan document, and (once assets exceed $250,000) an annual Form 5500-EZ filing. The setup is more involved than a SEP. Also, if you add even one non-spouse W-2 employee, the Solo 401(k) no longer qualifies and must be converted to a regular 401(k) plan.
Comparing the Two Directly
At lower income levels ($50,000–$100,000 net), the Solo 401(k) wins because the employee deferral allows much larger contributions as a percentage of income. A business netting $60,000 can contribute $24,500 via employee deferral plus additional profit-sharing, while the SEP would cap around $11,000.
At higher income levels ($200,000+), the maximum contribution amounts converge. At $276,000+ in W-2 compensation from an S-Corp, both plans can reach the $72,000 ceiling. At that income level, simplicity may favor the SEP.
For Roth: the Solo 401(k) wins unconditionally. If you believe your future tax rates will be higher than today, Roth contributions are valuable. The SEP offers none of this.
For employees: the SEP is more flexible if you have (or plan to add) employees. Adding employees to a Solo 401(k) requires converting to a full 401(k) plan with additional complexity and potential employer matching obligations.
A Third Option Worth Knowing: The Defined Benefit Plan
For very high earners who want to shelter more than $72,000 per year, a defined benefit (pension) plan can allow contributions of $200,000+ annually. These plans are complex and require an actuary to administer, but for a business owner aged 50+ with high income and no need to contribute the same amount every year, they can produce extraordinary tax savings.
Defined benefit plans can also be stacked with a Solo 401(k) for even higher combined contributions. This is specialist territory — if you’re netting $400,000+ and want aggressive tax deferral, ask your CPA whether a defined benefit plan makes sense.
Frequently Asked Questions
Q: Can I have both a SEP-IRA and a Solo 401(k)?
A: You cannot maximize both simultaneously — IRS rules limit total contributions across plans to $72,000. But you can have both account types and allocate contributions between them. In practice, most advisors recommend choosing one to simplify administration.
Q: What if I already have a W-2 job and also have self-employment income?
A: You can still open a Solo 401(k) or SEP-IRA for your self-employment income. The $24,500 employee deferral limit is shared across all 401(k) plans (your employer’s and your Solo 401(k)), but the employer profit-sharing contributions for each plan are separate.
Q: Is there an income limit to contribute to these plans?
A: No income phase-out for SEP-IRA or Solo 401(k) — unlike Roth IRAs, these plans don’t have phase-out limits. High earners can contribute without restriction.
Q: When should I set up my Solo 401(k) to capture this year’s contributions?
A: The plan must be established by December 31 of the plan year. You can fund it up until your tax filing deadline, but the plan itself must exist before year-end. This is a common mistake — owners wait until February to set up a plan and miss the prior year entirely.
Q: What if I have a few part-time employees — can I still use a Solo 401(k)?
A: Employees who work fewer than 1,000 hours per year (or less than 500 hours under SECURE 2.0 provisions) may be excludable. The rules are nuanced — verify with your CPA or plan administrator before assuming you qualify.
Choosing the right retirement account is one of the highest-leverage tax decisions a business owner can make. At Molen & Associates, we help business owners select, structure, and fund retirement plans as part of a comprehensive tax planning strategy. Schedule a consultation at molentax.com.
