Solo 401(k) vs. SEP IRA Contribution Optimizer

Why Compare Solo 401(k) and SEP IRA Plans?

Self-employed professionals and owner-only businesses often toggle between Solo 401(k) and SEP IRA plans when structuring retirement savings. Both vehicles permit large tax-deferred contributions, yet they differ in how contributions are calculated, whether employee elective deferrals are available, and how catch-up rules function for workers age fifty and older. The Solo 401(k) offers separate employee and employer contribution buckets, enabling higher savings on modest income, while a SEP IRA limits contributions to an employer profit-sharing formula. The decision ripples through tax planning, cash flow, and compliance obligations. This calculator streamlines the comparison by crunching the 2024 limits for both structures based on your business type and desired deferral strategy.

Because both plans cap annual additions at $69,000 for 2024 ($76,500 if catch-up deferrals apply), determining the optimal mix is not as simple as choosing the plan with the highest theoretical limit. Solo 401(k) deferrals are constrained by earned income after self-employment tax adjustments, while SEP IRA contributions hinge on compensation defined by the IRS. S corporation owners also face a different calculation than sole proprietors because salary is separated from business profits. The optimizer handles these nuances by adjusting income for self-employment tax, applying the correct employer percentage, and comparing the results in plain language.

Inputs the Optimizer Requires

Start by selecting your business structure. Sole proprietors and single- member LLCs taxed as disregarded entities enter their net self-employment income from Schedule C before retirement plan deductions. S corporation or C corporation owners enter total compensation paid to themselves as W-2 wages as well as any pass-through business income if they are taxed as S corporations. The calculator uses W-2 wages for employer contribution limits in the corporate scenario while referencing net earnings (reduced by the SE tax adjustment) for the sole proprietor case.

The age field determines whether you qualify for the $7,500 catch-up deferral available only in Solo 401(k) plans. SEP IRAs do not offer catch-ups, so older owners often lean toward Solo 401(k)s when cash flow supports the larger savings goal. Finally, the desired deferral input captures how much you wish to contribute as an employee elective deferral. The optimizer caps this amount at the IRS limit—$22,500 for 2024 plus the catch-up if eligible—and notes if your earnings are too low to support the requested deferral.

Understanding the Calculation Methodology

For sole proprietors, the calculator approximates net earnings subject to the retirement contribution formulas by multiplying net income by 92.35% to account for the deductible half of self-employment tax. It then applies a 20% employer contribution rate to this adjusted income for both the Solo 401(k) employer bucket and the SEP IRA contribution. Because the employer contribution reduces net earnings, the exact IRS computation is recursive, but this approximation mirrors the worksheet most tax software uses. The Solo 401(k) employee deferral is layered on top of the employer amount, limited by the smaller of your requested deferral or your adjusted net earnings.

For S corporations paying W-2 wages, the employer contribution for both plans equals 25% of eligible compensation, capped by the $330,000 compensation limit. The Solo 401(k) still allows employee elective deferrals up to $22,500 ($30,000 with catch-up), constrained by total W-2 wages. Because SEP IRAs consist solely of employer contributions, the optimizer highlights how income levels drive the maximum. If wages are low, the Solo 401(k)’s elective deferral makes it easier to hit the annual maximum.

Interpreting the Output

The result block compares three figures: total Solo 401(k) contribution (employee plus employer), total SEP IRA contribution, and the difference between the two. It also notes whether either plan hits the overall $69,000 annual additions cap or the $76,500 cap with catch-up. When the Solo 401(k) produces a higher contribution, the narrative explains which components drive the advantage—typically the elective deferral. When the SEP IRA matches or exceeds the Solo 401(k), the calculator clarifies that the plans converge at higher income levels because the $69,000 ceiling becomes the binding constraint for both.

A detailed summary string is available via the copy button so you can paste the scenario into your tax planning workbook or send it to a CPA. The summary includes each contribution component, the assumptions used for self-employment tax adjustments, and reminders about deductibility and filing deadlines. The intent is to create an auditable trail when you revisit the analysis during year-end planning.

Example Use Cases

Imagine a freelance designer earning $120,000 net before retirement contributions. After applying the 92.35% factor, adjusted earnings equal $110,820. The maximum SEP IRA contribution is roughly $22,164 (20% of the adjusted figure). With a Solo 401(k), the designer can add a $22,500 elective deferral plus the same $22,164 employer contribution for a total of $44,664—double the SEP option. The optimizer conveys this difference immediately, helping the designer justify the extra administrative work involved in maintaining a Solo 401(k).

Now consider a consultant who pays herself $200,000 in W-2 wages from an S corporation. Both plans allow a 25% employer contribution of $50,000. The Solo 401(k) adds a $22,500 deferral for a total of $72,500, but the annual additions limit reduces that to $69,000. The SEP IRA contribution remains $50,000, so the Solo 401(k) still wins by $19,000. If the owner is 52, the catch-up lifts the Solo 401(k) deferral to $30,000, yet the overall cap stays at $76,500, meaning only $26,500 of employer contribution is needed to hit the maximum. The optimizer explains these interactions so you can fine-tune salary and contribution decisions.

Strategic Planning Insights

Evaluating plan design is not merely an academic exercise. Solo 401(k)s require more paperwork, including Form 5500-EZ once assets exceed $250,000, and custodians may charge higher fees than SEP IRA providers. However, the ability to defer more income earlier in the business growth cycle often outweighs the administrative burden. The optimizer’s narrative section explores rollover rules, Roth deferral options, and how employing a spouse can expand contribution room. It also warns against exceeding compensation limits that trigger excise taxes.

Tax savings are another pivotal angle. Employer contributions are deductible for the business, while employee deferrals reduce taxable income on your individual return (unless you choose Roth deferrals). The calculator encourages you to project the immediate tax deduction from the higher contribution and weigh it against cash flow needs. It also highlights when a SEP IRA may be preferable because it permits funding up to the tax-filing deadline plus extensions, whereas Solo 401(k) employee deferrals generally must be elected by December 31.

Because the optimizer leans on approximations for self-employment tax, we recommend sharing the summary with a tax professional before making binding decisions. They can refine the inputs using your actual Schedule SE figures and ensure compliance with IRS Publication 560. The calculator is a planning aid, not a substitute for personalized advice, and the explanation reiterates this point to set expectations.

Frequently Asked Questions

Can I maintain both a Solo 401(k) and a SEP IRA? Yes, but contributions to both plans aggregate toward the same annual additions limit. Many owners keep a SEP IRA for legacy reasons yet direct new savings to a Solo 401(k) once higher contributions become necessary.

How do catch-up contributions work with a Solo 401(k)? Participants age 50 or older may defer an additional $7,500 beyond the standard $22,500 limit. Catch-up deferrals do not count toward the $69,000 annual additions cap, making Solo 401(k)s especially attractive for older owners with strong cash flow.

What if my business has common-law employees? This calculator assumes the owner is the only participant. If you hire employees, both plan types require broader coverage and nondiscrimination testing. Consult a benefits specialist before proceeding.

Does the optimizer account for Roth deferrals? The math focuses on contribution limits rather than tax treatment. Roth Solo 401(k) deferrals count toward the same limit but do not reduce taxable income. Use the summary output to decide how much to allocate to traditional versus Roth buckets.

How precise is the self-employment tax adjustment? The 92.35% factor mirrors the worksheet in IRS Publication 560 and suits planning conversations. Your final deduction should be calculated using Schedule SE when filing your return.