Compare a solo 401(k) and SEP IRA using eligible compensation, other employer contributions, staffing plans and administration—not just headline limits.
February 5, 2024 · Financial Forte Staff
Historical article: prepared retrospectively using information available as of February 5, 2024.
An owner-only business can generate enough income to make retirement saving a meaningful decision, even when it doesn't have a formal payroll department. That is often when a comparison between a solo 401(k) and a SEP IRA begins. The owner wants to know which allows more saving with less work.
Before comparing contribution amounts, identify how the owner earns income, whether anyone else works in the business and whether the owner participates in another employer's plan. Those facts can change the answer. The plan with the larger advertised limit may not produce the larger usable contribution in your circumstances.
Establish what owner-only actually means
A one-participant 401(k) generally covers a business owner with no common-law employees, or the owner and an eligible spouse working in the business. The plan's marketing name doesn't settle employee eligibility. Hiring staff, using a related company or changing the business structure can require another review.[1]
An LLC label alone doesn't tell you how to calculate retirement-plan compensation. Federal tax treatment matters. A sole proprietor's calculation differs from the W-2 compensation used for a working corporate owner. Shareholder distributions should not simply be substituted for wages in the latter calculation.[2]
A partnership raises additional questions because the partnership generally sponsors the plan and partner earned income has its own calculation. If more than one business is involved, ask the administrator to determine whether the arrangements must be considered together.
These are facts to establish before funding an account. Correcting an excess or improper contribution is less convenient than calculating it correctly at the outset.
Understand the two contribution roles
A solo 401(k) can allow the owner to contribute in an employee role through elective deferrals and in an employer role through employer contributions. A SEP contribution generally comes from the employer. That structural difference can matter when comparing the contribution available at a particular income level.[1]
For self-employed individuals, the compensation calculation is not simply gross revenue or cash withdrawn from the business. Relevant deductions and the retirement contribution calculation interact. Have the tax professional and administrator use the appropriate worksheet and the same income figures rather than applying a percentage to deposits in the checking account.[3]
Neither option turns money needed for payroll taxes, operating reserves or a near-term purchase into spare retirement cash. Establish an affordable contribution first, then determine what the rules permit. A maximum is a ceiling, not an instruction to contribute that amount.
Compare both plans using the same compensation
Take Priya, a hypothetical 42-year-old who owns an S corporation with no other employees, related businesses or retirement plans. For 2024, she receives $80,000 in eligible W-2 compensation. Any shareholder distributions are excluded from this calculation. Assume timely plan adoption and elections, no catch-up contribution, and plan terms allowing the contributions shown.[2][3]
| 2024 contribution | SEP IRA | Solo 401(k) |
|---|---|---|
| Employer: 25% of $80,000 W-2 compensation | $20,000 | $20,000 |
| Owner’s elective deferral | None under this SEP | $23,000 |
| Total in this example | $20,000 | $43,000 |
The solo 401(k) permits $23,000 more here because it adds the employee deferral. Both totals are below the 2024 $69,000 annual-additions limit, and the compensation supports the contributions under these assumptions. Priya’s $23,000 deferral comes from her wages; it is not another employer contribution on top of those wages.[3][4]
If Priya wants to save $15,000, both structures can accommodate that goal. The larger ceiling may not justify additional administration. If she wants to save $35,000, the solo 401(k) can accommodate it under these facts; the SEP cannot. She still needs enough personal and business cash after taxes and operating needs.
Now change one fact: Priya also defers $18,000 at an unrelated employer. Her shared $23,000 personal deferral limit leaves only $5,000 for this solo 401(k), reducing the illustrated total to $25,000. The SEP employer contribution remains $20,000. Contributions at unrelated employers and related businesses require different aggregation analyses; this example assumes the other employer is genuinely unrelated.[3][4]
This W-2 comparison should not be applied directly to a sole proprietor’s profit. A sole proprietor or partner must use the self-employed worksheet, including the deductible portion of self-employment tax and the contribution adjustment. The nominal 25% employer rate generally becomes 20% of adjusted net earnings before the owner’s contribution. Gross receipts and cash draws are not that figure.[3]
Compare administration over the life of the plan
Ask each provider what it will administer, what the owner must do and which deadlines apply to adoption, elections, funding and reporting. Those are different tasks. Don't assume the deadline for one automatically extends another.
A solo 401(k) can involve annual reporting requirements, including circumstances in which Form 5500-EZ is required. A SEP may involve less ongoing plan reporting, but employee eligibility, contribution calculations and proper documentation still matter. Have the provider identify the requirements that apply to the actual arrangement, including termination.[1][3]
Think ahead to hiring. A plan chosen when the owner is the only worker may need a different structure or administration once eligible employees participate. Discuss that possibility before signing a service agreement so the cost of change isn't a surprise.
An owner-only arrangement may fall outside ERISA Title I in circumstances where a staffed plan would not. That distinction does not erase tax qualification, recordkeeping or reporting duties. Confirm the applicable framework rather than borrowing a generic fiduciary checklist from a different type of plan.[5]
Choose using a reconciled calculation
Compare written proposals using the same investment and service scope. Suppose the SEP costs an invented $100 annually and the solo 401(k) $600, with equal investment expenses. The additional $500 might be worthwhile if Priya needs its extra saving capacity. If she plans to contribute only $15,000, she should identify another benefit that justifies it. These are illustrative fees, not provider quotes. Include filing support, termination charges and the work Priya must do herself.
Keep that calculation with the records used to prepare the return. Before the next contribution, revisit income, staffing and other-plan participation. The most useful improvement may be a repeatable annual process that prevents duplicate deferrals and mistaken compensation assumptions, rather than a more elaborate plan. At the annual review, compare the final payroll deferrals from every relevant employer with the amounts used in the contribution calculation.
Related reading
- A Side Business Does Not Give You a Second Personal Deferral Limit
- Before Your Solo 401(k) Business Adds an Employee
Have more questions about a solo 401(k), SEP IRA or owner contribution calculation? Email Dave at dave@financialforte.com to discuss your questions and next steps.
The contact invitation is current; it does not imply this contact path existed on the historical reference date.
Educational information, not personalized investment, tax, legal or benefits advice. Examples use hypothetical assumptions. Verify current rules and your circumstances before acting.
Sources
- [1] One-Participant 401(k) Plans — Current webpage retrieved 2026-11-11; Retirement Plans for Small Business — Publication 560 (2022) — 2023-03-17; 2022 edition
- [2] Employee Plans News — S corporation compensation — 2011-12-20
- [3] Retirement Plans for Small Business — Publication 560 (2022) — 2023-03-17; 2022 edition
- [4] IRS announces 2024 retirement limits — IR-2023-203 — 2023-11-01
- [5] DOL Advisory Opinion 1999-04A — 1999
