Solo business owners should proactively evaluate their retirement plan options because the right account can help you defer or deduct dollars in taxes each year.
This article breaks down SEP IRAs and solo 401(k)s, using the updated 2026 IRS limits, and explains why the solo 401(k) is often the more powerful option.
Why Many Solo Business Owners Start With a SEP IRA
Most self-employed individuals end up with a SEP IRA because accountants often recommend one at tax time. SEPs are simple to set up and can provide tax-deductible employer contributions.
How a SEP IRA Works (2026 Rules)
- Employer contributions only — no employee deferrals.
- 2026 maximum contribution: Up to $72,000 total.
- Contribution formulas:
- S-Corporation: Up to 25% of W-2 compensation.
- Sole proprietor / partnership: Up to 20% of net earnings (after IRS adjustments).
- Must contribute the same percentage for all eligible employees.
- Roth SEP contributions are allowed.
- Triggers the IRA pro rata rule, meaning:
If your income is too high for Roth IRA contributions, having a SEP IRA may prevent the Backdoor Roth IRA strategy.
Why Solo 401(k)s Are Often Excellent
A solo 401(k) is designed for a business with one owner and no W-2 employees (a spouse may participate).
How a Solo 401(k) Works (2026 Rules)
- Employee deferral limit: $24,500 in 2026.
- Catch-up (age 50+): Additional $8,000.
- Super catch-up (ages 60–63): $11,250
- Employer contribution: Up to 25% of compensation.
- Total maximum contribution (employee + employer):
- Under 50: Up to $72,000
- Age 50+: Up to $80,000
- Age 60–63: Up to $83,250
- Roth contributions allowed.
- Allows Backdoor Roth IRA contributions, because solo 401(k)s do not trigger the pro rata rule.
This is one of the biggest strategic advantages over a SEP.
Why I Prefer the Solo 401(k)
1. You can contribute more at the same income.
Because it includes both employee deferrals and employer contributions, the solo 401(k) allows many business owners to hit higher tax-advantaged savings levels compared to a SEP—especially at lower or moderate income levels.
2. It may enable the Backdoor Roth IRA strategy.
If your income exceeds Roth IRA limits, the solo 401(k) exempts your IRA balances from the pro rata calculation.
This means you can still fund a Roth IRA through a Roth conversion (Backdoor Roth)—a strategy that can help create valuable future tax-free dollars.
Important Note on Self-Employment Compensation
All contribution calculations hinge on “earned income,” which means:
- Net earnings from self-employment
minus - half of your self-employment tax
- retirement contributions made for yourself
These formulas affect both SEP and solo 401(k) employer contribution limits.
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