Your SEP IRA Worked at $150K. Here's Why It Costs You at $400K.

You opened a SEP IRA a few years back. Maybe your CPA recommended it. Maybe you read an article about how easy it was, set up in 15 minutes, fund before the tax deadline, no annual filings. At the time your practice or consultancy was clearing $150,000 or $200,000, and the SEP did what you needed: you put away a percentage of your income, took the deduction, and moved on.

But your income has grown since then. Maybe it's $400,000 now. Maybe more. And the SEP that worked at $150,000 is quietly leaving money on the table. Not because anything went wrong, but because the SEP's contribution formula was designed for a different income level.

How the SEP formula caps you

The SEP IRA works on a simple principle: an employer (your business) contributes up to 25% of your compensation to a retirement account. For a self-employed person, the math adjusts to 20% of net earnings from self-employment, because the contribution itself reduces your net earnings.

At $150,000 of net income, 20% gives you $30,000. That is a meaningful retirement contribution, and it fits comfortably under the annual limit.

At $400,000 of net income, 20% gives you $80,000 on paper. But the SEP has a hard dollar cap of $70,000 in 2026, so you are limited to $70,000. You are already hitting the ceiling. And if your income keeps climbing, the SEP cannot climb with it. Every dollar you earn above the point where 20% equals the cap does not generate any additional retirement tax deferral.

The SEP is a fixed percentage of a growing number, pressed against a fixed ceiling. The ceiling does not budge, so the percentage effectively shrinks.

What a solo 401k does differently

A solo 401k, also called an individual 401k, is designed for the same self-employed audience as the SEP, but it gives you two contribution streams instead of one.

The employee deferral lets you contribute up to $23,500 of your earned income as a salary deferral in 2026, or $31,000 if you are 50 or older. That money goes in pretax or as a Roth contribution, your choice.

The employer profit-sharing contribution allows your business to contribute up to 25% of your compensation (20% for self-employed), on top of your deferral.

The total across both streams is capped at $70,000 in 2026, or $77,500 if you are 50 or older.

The key difference is structural. With a SEP, every dollar is an employer contribution, and it is the only lever you have. With a solo 401k, you have two levers: your own deferral and the business contribution. That gives you more control over how and when you fund the account, and it opens options the SEP does not offer.

The practical difference at $400,000

Let us walk through how the math works in a representative situation. This is not your specific numbers, it is how the mechanics compare for someone earning $400,000 from self-employment.

With a SEP IRA, your business contributes 20% of $400,000, which is $80,000, but it is capped at $70,000. So you put away $70,000. One contribution. All pre-tax. That is it.

With a solo 401k, you can defer $23,500 as an employee. Your business then contributes up to 25% of your compensation on top. For a $400,000 earner, 20% of $400,000 is $80,000, but when you combine the employee deferral with the profit-sharing contribution, the total is capped at $70,000. So in raw dollars, the solo 401k also lands at $70,000.

The difference is not in the total dollar amount at this income level. The difference is in what you can do with those dollars.

With the solo 401k, you can elect to make your $23,500 deferral as a Roth contribution. That means you pay tax on that money now, but it grows and is distributed tax-free in retirement. The SEP gives you no Roth option at all.

With the solo 401k, if you need access to the funds before retirement, you can take a loan from the account, up to $50,000 or half the balance, whichever is less. The SEP has no loan provision.

With the solo 401k, if your income pushes past $400,000 toward $500,000 or more, you can combine it with a cash balance or defined benefit plan to shelter additional income. A SEP cannot be paired with a defined benefit plan in the same way.

And if you are 50 or older, the solo 401k gives you a $7,500 catch-up contribution on the employee deferral side, for a total cap of $77,500. The SEP's one-size-fits-all cap does not offer a catch-up.

When the SEP still wins

The SEP is not a bad plan. It is simple to set up, there is no annual filing requirement until the account exceeds $250,000, and the contribution deadline is your tax filing deadline including extensions. If your income is under $200,000 and you value simplicity over optimization, a SEP is a perfectly reasonable choice.

The SEP also works better when you have employees. A solo 401k requires that any full-time employee who meets the eligibility criteria also receive the same profit-sharing contribution, the same rule applies to SEPs, but solo 401k administration is slightly more involved if you have staff.

Where the SEP costs you is at higher income, when you want Roth access, when you want loan features, or when you want to layer a defined benefit plan on top.

What a solo 401k means for your entity choice

There is one more layer worth noting. A solo 401k is only available to a business owner with no full-time employees besides a spouse. And the type of entity you use, sole proprietorship, LLC, or S corp, affects how the contribution limits work in practice. As we covered in a recent post on how your entity choice caps your solo 401k, the structure you pick for your business directly affects how much you can actually put away in retirement.

If you are still running your business as a sole proprietor or a single-member LLC, setting up a solo 401k is straightforward. If you have made an S corp election, your compensation is your W-2 salary, and the solo 401k contributions are based on that salary. That changes the numbers, and it is worth running both scenarios before you decide which plan fits.

What to do next

If you opened a SEP IRA when your income was lower and have never revisited the decision, it is worth a conversation. Not because the SEP is bad, but because the right plan depends on where you are now, not where you were five years ago.

A 15-minute discovery call is enough to compare your current setup against the alternatives. No commitment, no hard sell. Just a clear look at whether your retirement plan is keeping up with your income.

Call (619) 280-2700 or email info@RoadmapTax.com to schedule yours.

FAQ

What is the main difference between a SEP IRA and a solo 401k?

A SEP IRA allows employer contributions only, capped at 25% of compensation. A solo 401k allows both an employee deferral and an employer profit-sharing contribution, with the same total cap but more flexibility including Roth contributions and loan provisions.

How much can I contribute to a solo 401k in 2026?

The total contribution limit for a solo 401k in 2026 is $70,000, or $77,500 if you are 50 or older. This includes up to $23,500 in employee deferrals plus employer profit-sharing contributions.

Can I have both a SEP IRA and a solo 401k?

You can maintain both accounts, but the total combined contributions across all retirement plans cannot exceed the annual limit. In practice, most high earners consolidate into one plan rather than split contributions across two.

When does a SEP IRA make more sense than a solo 401k?

A SEP makes sense when your income is under $200,000, when you value maximum simplicity, when you have employees you need to cover, or when you do not want to file Form 5500. The SEP also offers a later contribution deadline than the solo 401k.

Does a solo 401k require annual filings?

Yes, once the account balance exceeds $250,000, you must file Form 5500-EZ annually. This is a relatively simple filing, but it is an additional compliance step that SEP IRAs do not require.

Can I convert my SEP IRA to a solo 401k?

Yes, you can roll over SEP IRA funds into a solo 401k. The process is straightforward and does not trigger a taxable event when done as a direct rollover. This is a common move for high earners switching between plans.