The Verdict, Before We Get Into the Weeds
You’ve got a W-2 job with a 401k, and now a consulting gig or a side business is throwing off real money. You need somewhere to put it that isn’t a taxable brokerage account. For most tech workers in this exact spot, open a solo 401k, not a SEP IRA.
The solo 401k gives you more contribution flexibility, doesn’t interfere with a backdoor Roth IRA, and offers a Roth option. The SEP IRA’s real advantage is narrow: you can open and fund one right up until your tax filing deadline, months after the solo 401k’s setup window has closed. If you’re reading this in February about last year’s income, that one fact might matter more than everything else in this article.
The Solo 401k’s Two Hats
A solo 401k (also called an individual 401k or one-participant 401k) lets you contribute in two separate capacities, because you’re wearing two hats: you’re both the employee and the employer of your own business.
Employee deferral: You can defer part of your net self-employment earnings, the same way you’d defer part of a paycheck into a regular 401k. This side is capped by the annual elective deferral limit (assume $23,500 for this article, but confirm the actual figure for the year you’re contributing, since it adjusts annually).
Employer profit-sharing contribution: Your business, as the employer, can also kick in a contribution calculated as a percentage of your net self-employment earnings. This is on top of the employee deferral, up to an overall combined cap (assume roughly $70,000 for this article, again confirm the current-year number).
Two hats, two separate contribution streams, one combined ceiling. That structure is the entire reason a solo 401k tends to beat a SEP IRA at the income levels most tech workers side hustle at.
The Shared Limit That Ruins Everyone’s Day
Here’s the constraint that trips people up, and it’s the one you need to internalize before you get excited about “two contribution streams.”
The employee deferral limit is not per plan. It’s per person, aggregated across every 401k, 403(b), and similar plan you participate in during the calendar year. If you’re already deferring the maximum at your W-2 job, you have $0 of employee deferral room left for a solo 401k on your side income. None. The IRS does not care that the money came from a different employer, a different EIN, or a completely different line of work.
This is the single most common mistake people make when they hear “solo 401k lets you defer up to $23,500 in addition to your day job.” No, it doesn’t. It lets you defer up to $23,500 total, and if your day job already used that up, your side gig only gets the employer side.
That doesn’t mean the solo 401k stops being useful once your deferral is maxed elsewhere. It means you need to evaluate it correctly, which is what the worked example below does.
The SEP IRA: Employer Money Only
A SEP IRA (Simplified Employee Pension) skips the two-hat structure entirely. There’s no employee deferral option at all, ever, for anyone. Every dollar that goes in is an employer contribution, calculated as a percentage of your net self-employment earnings.
For a sole proprietor, that contribution rate works out to a smaller effective percentage than the stated 25% cap you’ll see quoted everywhere, because the IRS defines your “compensation” for this calculation as your net earnings minus the contribution itself. Once you solve that circular math, the practical rate lands at roughly 20% of your adjusted net self-employment earnings, not 25%. Anyone quoting you a flat 25% for a sole proprietor is skipping a step.
Why the Solo 401k Usually Still Wins on Room
The SEP IRA’s employer-contribution formula and the solo 401k’s employer-contribution formula are the same math, which surprises a lot of people. Both use that same roughly-20%-of-adjusted-net-earnings calculation for a sole proprietor. Dollar for dollar, on the employer side alone, a SEP and a solo 401k give you the identical number.
So where does the solo 401k’s reputation for “more room” come from? The employee deferral. If you have any deferral room left, meaning you haven’t already maxed a 401k elsewhere, the solo 401k lets you stack that deferral on top of the employer contribution, while the SEP has nothing to stack. At modest income levels, that stacked employee deferral is often bigger than the employer contribution itself. A consultant with $30,000 in net side income and no competing W-2 plan can defer nearly all of it as an employee contribution, something a SEP simply cannot offer at any income level.
If your side income is your only income, or your W-2 job’s 401k doesn’t eat your whole deferral limit, the solo 401k wins on pure dollars, often by a wide margin. If your W-2 job already maxes your deferral, the picture changes, and that’s exactly the scenario worth running the numbers on.
The Worked Example: You, Already Maxed at Your Day Job
Let’s say you’re a senior engineer who already defers the full employee limit into your W-2 401k. Your side consulting gig nets $45,000 in Schedule C profit after expenses. Here’s what each account gives you, with the arithmetic verified rather than eyeballed.
Step 1: Get from net profit to net self-employment earnings.
- Net profit (Schedule C): $45,000
- SE tax base (92.35% of net profit): $41,557.50
- SE tax (15.3% of that base): $6,358.30
- Deduct half the SE tax (above-the-line): $3,179.15
- Net self-employment earnings after that deduction: $41,820.85
Step 2: Employer contribution, both plan types.
- Solo 401k employer contribution (roughly 20% of $41,820.85): $8,364.17
- SEP IRA contribution (same roughly-20% formula): $8,364.17
Identical. No advantage either way, on the employer side alone.
Step 3: Employee deferral, solo 401k only.
Because you’re already maxing your deferral at your day job, you have $0 of employee deferral room left for the solo 401k this year.
- Solo 401k total: $8,364.17 (employer contribution only)
- SEP IRA total: $8,364.17 (employer contribution, its only option)
In this exact scenario, both accounts hold the same amount of money. If you weren’t maxing your W-2 deferral (say you’d only put in $10,000 there, leaving $13,500 of shared room), the solo 401k would let you add that $13,500 as an employee deferral on top of the $8,364 employer piece, for a $21,864 total against the SEP’s flat $8,364. That gap is where the solo 401k’s reputation comes from. It just doesn’t show up if your day job already used the room.
So if the dollar amount is a wash for someone already maxing their deferral, why does this article still say pick the solo 401k? Keep reading.
The Backdoor Roth Trap Nobody Warns You About
This is the point that should actually decide things for a lot of tech workers, and it has nothing to do with contribution room.
If you earn too much to contribute to a Roth IRA directly, you’re probably doing a backdoor Roth: contribute to a traditional IRA, then convert it to Roth. That conversion is clean and tax-free only if you have no other pre-tax IRA money sitting around, because the IRS makes you calculate the taxable portion of any Roth conversion using the pro-rata rule across the combined balance of every traditional, SEP, and SIMPLE IRA you own, not just the one account you’re converting.
A SEP IRA is, for this purpose, just another traditional IRA. Open one and start funding it, and every dollar in it now counts toward your pro-rata calculation. Your previously clean backdoor Roth conversion turns into a partially taxable mess, recalculated every single year the SEP balance exists, for as long as you hold it.
A solo 401k doesn’t have this problem. It’s an employer-sponsored plan, not an IRA, so its balance is completely excluded from the IRA pro-rata calculation. You can have $200,000 in a solo 401k and still do a perfectly clean backdoor Roth conversion every year, no math contamination at all.
If you’re anywhere near the income where a backdoor Roth matters to you, this single fact should end the debate. A SEP IRA doesn’t just fail to help here, it actively breaks a strategy you’re probably already relying on.
Roth Solo 401k: The Bonus Round
Most solo 401k providers also let you designate your employee deferral as Roth instead of pre-tax, same as a regular workplace 401k’s Roth option. You pay tax on that money now and it grows tax-free forever, with no taxable withdrawals in retirement. Whether that’s the right call depends on whether you expect your retirement tax bracket to beat your current one, the usual pre-tax-versus-Roth tradeoff, just available on your side income too.
A SEP IRA has no Roth version at all. Every dollar that goes in is pre-tax, and that’s the only option you get.
Setup Deadlines: The One Place SEP Actually Wins
This is where the SEP earns its keep. You can open and fund a SEP IRA as late as your tax filing deadline, extensions included, for the prior tax year. Realize in March that you should’ve been sheltering last year’s consulting income, and a SEP can still absorb it.
A solo 401k used to require the plan itself be established by December 31 of the tax year, no exceptions, even if you didn’t fund it until later. Recent law changes loosened this: a sole proprietor can now generally open a solo 401k after year-end, up to the filing deadline, as long as that year’s contribution comes entirely from the employer side (an employee deferral has to be elected before the year closes, so a late-opened plan for that first year typically can’t include one). Rules and provider practices vary here, so confirm the current deadline with whatever brokerage you’re using before you assume you have until April for everything.
If you’re reading this article in the first half of the year, this distinction barely matters, open either one with time to spare. If you’re scrambling in Q1 to shelter last year’s side income, it might be the whole decision.
The Paperwork Tax at Higher Balances
Once a solo 401k’s assets cross a threshold (confirm the current figure, it’s adjusted periodically and has moved before), you’re required to file Form 5500-EZ with the IRS annually. It’s not a hard form, but it’s one more thing on your calendar that a SEP IRA never asks of you, at any balance, ever.
For most people in year one or two of a side business, this doesn’t matter. If your side income has been running for a decade and the account is large, it’s a real, if minor, administrative difference to factor in.
Who Should Still Pick a SEP
The solo 401k isn’t universally correct. Pick a SEP IRA if any of these apply to you:
- You need to fund a retirement account for last year’s income and you’re past the solo 401k’s setup window.
- Your side business has, or might soon have, common-law employees other than you and a spouse. Solo 401ks require you to have no other eligible employees; a SEP can cover a small team, though you’ll owe them the same contribution percentage you take for yourself.
- You have no plans to ever do a backdoor Roth IRA and you just want the simplest possible paperwork, one form to open an account and nothing to file annually.
- Your side income is small and irregular enough that the extra plan document and administration of a solo 401k isn’t worth the hassle for a contribution that’s identical to what a SEP would give you anyway.
Outside of those cases, the solo 401k is the better default.
The Bottom Line
At the exact same net self-employment income, the employer-side contribution in a solo 401k and a SEP IRA is the same number. The solo 401k pulls ahead when you still have employee deferral room left after your W-2 job, it adds a Roth option your SEP will never have, and it stays completely clear of the IRA pro-rata rule that a SEP will happily wreck for you.
Check your current deferral usage at your day job, confirm this year’s contribution limits and deadlines with your solo 401k or SEP provider before you assume last year’s numbers still apply, and open the account before you need it, not the week before you file.
