Solo 401(k) or SEP-IRA, and what changes when you hire

If you own the business you are the employer and the employee at once. That doubles the routes money can take into a retirement account, and it makes the usual IRA-versus-401(k) comparison close to useless for you.

The two plans worth putting side by side are the Solo 401(k) and the SEP-IRA.

What each one is

A SEP-IRA takes employer money only. You cannot defer salary into it. For 2026 the ceiling is the lesser of 25% of compensation or $72,000, and the compensation that counts is capped at $360,000. In exchange for the single route in, it is the easier plan to live with. No annual return in most cases, very little paperwork, and you can open it and fund it as late as the due date of your return including extensions.

One catch surprises sole proprietors and partners every year. That 25% applies to a smaller base than you would expect, because your compensation for this purpose is net earnings reduced by half your self-employment tax and by the contribution itself, which is circular. The shortcut is that 25% works out to 20% of net earnings. Same limit, different denominator.

A Solo 401(k) is open to a business whose only participants are the owner and a spouse. Money gets in two ways. You defer up to $24,500 of your own compensation in 2026, and the business makes an employer contribution on top, with one overall ceiling of $72,000 covering both. At 50 you can add $8,000. Between 60 and 63 that rises to $11,250, which puts the practical ceilings at $80,000 and $83,250. At 64 you drop back to $8,000.

Why the Solo 401(k) usually wins on room

The deferral is the whole reason. A SEP has no equivalent, so at moderate compensation the Solo 401(k) puts more away, and the SEP only catches up once a percentage of a large salary beats the deferral plus the employer piece. Our Solo 401(k) vs SEP-IRA calculator shows both figures for your own income.

An S corporation owner paying themselves a modest but defensible salary can often get substantially more into a Solo 401(k) than into a SEP at the same income, for the plain reason that there are two doors rather than one.

Roth treatment is the second difference, and it is more one-sided than most articles admit. A Solo 401(k) can take Roth deferrals. SECURE 2.0 made Roth SEP contributions legal in 2023, but the plumbing has not followed. The IRS model SEP document, Form 5305-SEP, is still the December 2004 revision and says in terms that you may not make SEP contributions to a Roth IRA, so any plan running on that document is out. Vanguard has said publicly that it will not offer the option. Fidelity, Schwab, E*TRADE and Merrill Edge all describe SEP money as deductible employer contributions with no Roth alternative. A handful of smaller providers advertise it. If Roth matters to you, the 401(k) is where you will find it without a hunt.

Then there is borrowing. A Solo 401(k) can permit participant loans if the plan document allows them. A SEP-IRA cannot, at all.

The SEP wins on administration, and it wins outright. A Solo 401(k) needs a plan document, and once the assets across every one-participant plan you run pass $250,000 you file a Form 5500-EZ each year, due seven months after the plan year ends. You also file in the plan's final year whatever the balance is. None of that is difficult. It is simply a thing that turns up every year and has to be done.

A 2026 rule that can stop a catch-up dead

This one is new enough that plenty of plan documents have not caught up with it.

If you are an S corporation shareholder-employee and your 2025 Social Security wages topped $150,000, any catch-up contribution you make in 2026 has to go in as Roth. The administrative transition period that let plans ignore the rule expired on December 31, 2025.

The sharp end is the document. If your Solo 401(k) has no Roth feature, you cannot make a catch-up contribution at all, not merely a smaller one. The measure is FICA wages from the employer sponsoring the plan, so a sole proprietor or a partner drawing no W-2 wages sits outside it, and it does not touch SEPs or SIMPLEs. Worth checking the document now rather than in the third week of December.

Hiring is the real decision

Contribution limits are what people ask about. What actually settles the choice is whether you are going to take somebody on.

A Solo 401(k) stays solo only while nobody but you and a spouse is eligible. A plan can hold new people out until they are 21 and have a year of service, but since plan years beginning after December 31, 2024 an employee who works 500 hours or more in two consecutive years becomes eligible to defer regardless. One qualifying hire and the plan is no longer a one-participant plan.

What follows is more than a change of paperwork. The plan comes under ERISA, which brings participant disclosures, fiduciary duties and a fidelity bond. Filing moves from the Form 5500-EZ to a full Form 5500 or 5500-SF, and the $250,000 exemption goes with it, so you file whatever the plan holds. Coverage, nondiscrimination and top-heavy testing all switch on. An owner-only plan that has just admitted its first employee is close to always top-heavy, and top-heavy means a minimum contribution for that employee and faster vesting.

A SEP handles growth differently and not more cheaply. Employer contributions have to go in on a uniform basis: the percentage you give yourself is the percentage everyone eligible gets. Simple to administer, expensive to fund. Its eligibility test is also harder to plan around than the 401(k)'s, because it reaches back. Age 21, worked in three of the last five years, and at least $800 of 2026 compensation.

So the question to answer first is not which plan gives you the bigger number this year. It is what the business looks like in three years. Changing plans later is possible, and it tends to become necessary at the least convenient moment.

Why this is a fall conversation

Opening a plan and funding a plan are two different deadlines, and the gap between them is the reason not to leave this until April.

The SEP is forgiving. Establish it and fund it by the due date of your return including extensions, which for a 2026 calendar year can be as late as October 2027 for a sole proprietor.

The Solo 401(k) is not, because you cannot defer compensation you have already taken. The plan has to exist and the deferral election has to be made by December 31, 2026. A sole proprietor's compensation is treated as becoming available on the last day of the tax year; an S corporation owner's wages become available with each payroll run. There is one narrow way round it: a sole proprietor with no employees setting up a brand new plan can adopt as late as the filing deadline, but without extensions, so April 15, 2027 rather than October.

The employer contribution is the relaxed half. You can add a profit-sharing contribution, and even adopt a plan retroactively to make one, up to the extended return deadline. That route buys you the employer piece. It never buys you the deferral.

How we approach it

We run both sets of numbers before recommending either, using your actual compensation, your entity structure, whether you expect to hire, and what you are already paying in self-employment or payroll tax. The plan choice sits downstream of those. That work is part of what we do for owner-managed businesses.

If you are a client, the documents are in TaxDome and we will have the projection open when we meet. If you are not, it is a conversation worth having before the year closes.

Common questions

Can I have both a Solo 401(k) and an IRA?

Usually, though whether the IRA contribution is deductible depends on your income and on being covered by a workplace plan. For 2026 the deduction phases out between $81,000 and $91,000 for a single filer who is covered, and between $129,000 and $149,000 for a married couple filing jointly where the contributor is covered.

I have a side business as well as a job with a 401(k). Does that change things?

Yes, and this is the point missed most often. The $24,500 deferral limit belongs to you as a person, across every plan you are in. The $72,000 overall limit is measured separately for each employer that is genuinely unrelated to the others. So you can max the deferral at the day job and still put an employer profit-sharing contribution into a Solo 401(k) for the side business, up to a second $72,000 cap limited by that business's compensation. Coordinating that across a job and a business is personal tax and retirement planning as much as business advice.

The caveat carries real weight. If the two businesses form a controlled group or an affiliated service group, they count as one employer and there is one cap between them. Spouse-owned businesses and professional service arrangements fail that test regularly.

What if I already have a SEP and want to switch?

Doable. The sequencing matters in the year you change, and there are interactions with rollovers and with the pro-rata rule if a Roth conversion is anywhere in your plans.

Does my entity type affect which plan I can use?

It affects how the employer contribution is calculated more than which plan you can have. A sole proprietor, a partner and an S corporation shareholder-employee each compute it differently, and only the S corporation owner is exposed to the Roth catch-up rule above. That is one reason the entity question and the retirement plan question belong in the same meeting. Our piece on the S corporation election covers the first half.