Why a solo 401(k) beats a SEP at most income levels
A one-participant 401(k) — often called a solo 401(k) or individual 401(k) — covers a business owner with no employees other than a spouse. Its advantage over a SEP IRA is that you wear two hats. As the employee you may defer up to the elective deferral limit regardless of how modest your profit is, and as the employer you may contribute a percentage of compensation on top. A SEP allows only the employer piece.
The difference is largest at low and moderate income. On $50,000 of Schedule C profit, the employer piece alone is roughly $9,294, while a solo 401(k) adds a deferral of up to the full statutory limit on top of it. At high income the two converge, because both eventually run into the same annual additions ceiling.
The calculator applies the limits in the order the rules require: compute plan compensation, take the employee deferral first, then fit the employer contribution into whatever room remains under the annual additions limit, and never let the total exceed compensation. That ordering matters at both ends of the income range and is where most quick estimates go wrong.
Where 92.35% and 20% come from
Two constants dominate the self-employed calculation and both have clean derivations. Both come from the deduction worksheet for the self-employed in IRS Publication 560, which is the authority for everything in this section.
The 92.35% factor. An employee's Social Security and Medicare tax is split with the employer, and only the employee half is paid out of wages. A self-employed person pays both halves, so to put them on equal footing the law applies the combined 15.3% rate to only 92.35% of net profit. That figure is 1 − 0.0765, the employer half of the combined rate — the same adjustment an employer makes by deducting its share before computing wages.
The 20% rate. A corporate plan may contribute 25% of compensation, and for an employee that compensation is a fixed W-2 number. For a sole proprietor, the contribution itself reduces earned income, so the base moves as you contribute. Write C for net earnings before the contribution and X for the contribution: the rule is X = 0.25(C − X). Solve it — X + 0.25X = 0.25C, so 1.25X = 0.25C and X = 0.2C. The 20% is the same 25% rule stated against the pre-contribution base. It is not a lower allowance.
Plan compensation is net profit minus half the self-employment tax, because that half is deductible in arriving at earned income. Self-employment tax itself is 12.4% for Social Security on the smaller of your SE base and the wage base, plus 2.9% for Medicare on the whole SE base with no ceiling. The extra 0.9% additional Medicare tax on high earners is neither halved nor deducted, so it is excluded from this calculation.
The caps. Section 402(g) limits your elective deferral across all plans you participate in — a single personal limit, not one per employer. Section 415(c) limits total annual additions per plan, and catch-up contributions sit outside it, which is why a participant over 50 can exceed the headline figure by the catch-up amount. Finally, no plan may credit more than 100% of your compensation, which is what binds at low profit.
Worked example: $100,000 of Schedule C profit at age 45
Using the calculator's defaults and the 2025 limits.
- Self-employment tax base. $100,000 × 0.9235 = $92,350.
- Social Security portion. $92,350 is below the $176,100 wage base, so the whole amount is taxed: $92,350 × 0.124 = $11,451.40.
- Medicare portion. $92,350 × 0.029 = $2,678.15.
- Total SE tax. $11,451.40 + $2,678.15 = $14,129.55. Half of it is $7,064.78.
- Plan compensation. $100,000 − $7,064.78 = $92,935.23.
- Employer contribution. 20% × $92,935.23 = $18,587.05.
- Employee deferral. The full $23,500 limit is available because plan compensation comfortably exceeds it.
- Check the annual additions limit. $23,500 + $18,587.05 = $42,087.05, well inside the $70,000 ceiling, so nothing is trimmed.
- Total. $42,087.05, or 42.1% of net profit, all of it deductible in arriving at adjusted gross income.
Compare this with a SEP IRA on the same profit. A SEP allows the employer piece only, so the maximum would be $18,587.05 — the solo 401(k) permits $23,500 more, which is $23,500 of income sheltered that the SEP simply cannot reach. The gap closes only once profit is high enough for 20% of compensation to approach the annual additions limit on its own, which happens above roughly $250,000 of net profit.
Choosing an entity, and the deadlines that bite
The S-corporation comparison is less one-sided than it looks. At $100,000, a Schedule C filer here reaches $42,087.05 while an S-corporation owner paying themselves $100,000 in wages reaches $48,500 — because 25% of $100,000 exceeds 20% of the post-SE-tax base. But the corporation also pays employer payroll taxes on those wages, and its owner takes distributions that are not eligible compensation. Owners who minimise wages to save payroll tax cut their maximum contribution at the same time, which is a real trade-off rather than a free lunch.
Deadlines are where people lose the deduction entirely. The plan must generally be established by the employer's tax filing deadline including extensions for the year in which the first contribution is made, under the rule introduced by the SECURE Act. The employer contribution can be funded up to that filing deadline. The employee deferral is different: it is an election about your own compensation and must be elected by year end, even where the money is deposited later. Missing the election deadline forfeits the deferral piece for that year, which is the larger of the two amounts at moderate income.
Watch the controlled group rules if you have more than one business. Ownership across related entities is aggregated, and employees of a related business can destroy the “no employees” premise of a one-participant plan. Similarly, once you hire a non-spouse employee who meets the plan's eligibility conditions, the plan is no longer a one-participant plan and becomes subject to nondiscrimination testing and Form 5500 filing.
One more coordination point: the section 402(g) deferral limit is personal, not per plan. If you also participate in an employer 401(k) at a day job, deferrals across both plans share one limit. The employer contribution to your solo plan does not, because section 415(c) is applied per unrelated employer — which is why a side business can add substantial employer contributions even when your day-job deferrals are already maxed. Use the 401(k) match calculator to see how much of that day-job limit the match already requires.
Maximum Schedule C contribution by net profit, under 50
| Net profit | Plan compensation | Employer ceiling (20%) | Employee deferral | Total |
|---|---|---|---|---|
| $50,000 | $46,467.61 | $9,293.52 | $23,500 | $32,793.52 |
| $75,000 | $69,701.42 | $13,940.28 | $23,500 | $37,440.28 |
| $100,000 | $92,935.23 | $18,587.05 | $23,500 | $42,087.05 |
| $150,000 | $139,402.84 | $27,880.57 | $23,500 | $51,380.57 |
| $200,000 | $186,403.65 | $37,280.73 | $23,500 | $60,780.73 |
| $250,000 | $235,734.11 | $47,146.82 | $23,500 | $70,000.00 |
In the last row the employer ceiling of $47,146.82 is trimmed to $46,500 because the $70,000 annual additions limit binds: 70,000 − 23,500 = 46,500. Plan compensation reaches that trigger at $232,500, which is why the total stops rising above roughly $250,000 of profit.
Mistakes that shrink or invalidate the contribution
- Applying 25% to Schedule C net profit. The correct rate against net profit is 20%, and it applies to compensation after half the self-employment tax rather than to the profit figure itself.
- Forgetting the half-SE-tax deduction. On $100,000 of profit it reduces the base by $7,064.78, which is $1,412.96 of employer contribution.
- Missing the year-end deferral election. The employee deferral requires an election by 31 December even though funding can follow later; the employer piece can wait until the filing deadline.
- Double-counting the deferral limit. Section 402(g) is one limit per person across every plan you participate in, so a day-job 401(k) deferral uses up the same allowance.
- Ignoring employees. A non-spouse employee who satisfies the plan's eligibility rules ends the one-participant status, with testing and filing consequences.
- Assuming the total limit includes catch-up. It does not. Catch-up contributions sit outside section 415(c), so an eligible participant's true ceiling is the annual additions limit plus the catch-up amount.
Pre-tax, Roth, and what to do with the money afterwards
Most solo 401(k) documents permit Roth elective deferrals, and employer contributions may now also be designated Roth if the plan allows. The choice does not change the limits — it changes when the tax is paid. Pre-tax deferrals reduce this year's adjusted gross income; Roth deferrals do not, and the account comes out tax-free later. The rate comparison is the same one set out in the traditional versus Roth calculator, and it applies with extra force to business owners whose income varies year to year: defer pre-tax in a strong year, contribute Roth in a lean one.
A large pre-tax solo 401(k) balance also creates a future problem worth planning for. It becomes subject to required minimum distributions, and it blocks a clean backdoor Roth if it is ever rolled into an IRA, because the pro-rata rule aggregates IRA balances. Both are reasons to consider converting some of it during low-income years — the Roth conversion tax calculator prices that, and the RMD calculator shows what the balance will eventually force out.
Finally, treat the contribution limit as a ceiling rather than a target. What matters is whether your savings rate supports the retirement you want, which is a function of spending rather than of tax law. Check the required balance with the retirement savings needed calculator and project the account with the 401(k) growth calculator. This page is an estimate of statutory limits, not tax advice; confirm the current year's figures and your own facts with a tax professional before contributing.