SEP-IRA vs. Solo 401(k): Why Opening the Plan Before Counting Employees Backfires

Gus begins with the payroll question

Gus is 63, and his commercial landscaping company has 40 employees. Deborah, 60, runs payroll. Their son runs the crews and wants to buy in. A $6 million private-equity offer sits on one side and a ten-year sale to their son on the other, and nobody expects income to stay even between now and closing.

They already hold about $700,000 in a SEP-IRA outside the company, and they'd like to put away more in the strong years. Gus's first question is whether a solo 401(k) beats it. At Apollon Wealth Management, the first working check isn't a calculation. A solo 401(k) generally fits only when the company employs no eligible common-law employees apart from the owner and the owner's spouse, so an employee census comes before contribution math.

Gus doesn't get to call the plan solo because he owns the company. Forty people on payroll settle that before any worksheet opens.

What does a solo 401(k) actually add over a SEP-IRA?

A solo 401(k) adds an employee deferral, up to $24,500 in 2026 under the IRS limit, on top of an employer contribution, while a SEP-IRA accepts only the employer contribution. That extra layer is why the solo plan can reach the $72,000 total limit at moderate pay, before any catch-up.

Tax first. Traditional contributions to either plan generally defer income tax now, and distributions generally enter taxable income later. For Gus that may shift the tax cost to retirement rather than erase it, and the saving is real only if his bracket later is lower than today's, or if he'd otherwise spend the money.

The base for the employer share matters too. An S corporation owner generally figures it from W-2 compensation, not company revenue. A sole proprietor uses net earnings under a special calculation that subtracts the deductible portion of self-employment tax and the contribution itself. The table below lines up the points where the SEP-IRA and the solo 401(k) differ.

The contribution math Gus runs before changing anything

A hypothetical household, Gus and Deborah, compare plans in a year when Gus draws $160,000 of W-2 compensation from his S corporation. Gus is 63, so the age-60-to-63 catch-up applies if a 401(k) is open to him. Everything here is for illustration, and the calculator on this site runs the same steps with your own pay.

Start with the SEP-IRA, since it's the plan they already have. The employer contribution is 25 percent of compensation: $160,000 × 25 percent = $40,000. A SEP-IRA has no employee deferral and no catch-up, so $40,000 is the whole amount.

Now the solo 401(k), assuming Gus had no eligible employees. First comes the employee deferral, $24,500 for 2026. Then the same $40,000 employer contribution. Then the $11,250 catch-up. Add them: $24,500 + $40,000 + $11,250 = $75,750, which stays under the $72,000 limit on deferral plus employer money because that pair totals $64,500.

The gap is $75,750 − $40,000 = $35,750 of additional deferred income, if the plan is permitted and the cash is there to fund it. What it saves depends on the bracket those dollars would otherwise land in, and that number comes from Gus's own return. Uneven income matters here: in a $60,000 year the $24,500 deferral doesn't shrink, while 25 percent of pay does.

Deborah's payroll role adds nothing by itself. Her room exists only if she has her own W-2 pay from the company.

One surprise for owners: the new account would hold only $75,750 after the deposit, under six figures, and the decision still matters. The existing $700,000 SEP-IRA adds no contribution room at all. Room comes from pay, not from the balance.

Then comes the part the arithmetic hides. Gus has 40 employees, so the census, not the attractive $35,750, decides whether he can use the solo option. Opening a solo 401(k) before that count is a timing mistake: money goes in first, and if the arrangement doesn't fit the workforce, the correction comes after the deposits, with paperwork and possible tax cost attached.

If the census says no, the next step is pricing a regular workplace plan. For an owner with 40 on payroll, that may also point toward cash balance plans, which we cover separately.

Step one: the SEP-IRA amount

Step two: the solo 401(k) amount and the gap

How much does income change the result?

At $80,000 of W-2 compensation, a qualifying owner age 60 to 63 can reach $55,750 in a solo 401(k) against $20,000 in a SEP-IRA. At $240,000 the gap narrows to $23,250, because the IRS $72,000 defined-contribution limit caps the combined deferral and employer layer.

The gap starts to shrink in the $240,000 row. At $80,000 and $160,000 it stays at $35,750, which is exactly the $24,500 deferral plus the $11,250 catch-up, so the employee deferral gives the solo plan its edge at lower and middle pay. Higher up, 25 percent of pay plus the deferral would pass $72,000, and the extra room disappears.

Catch-up contributions sit above the $72,000 limit, which is why the largest solo amount shown is $72,000 + $11,250 = $83,250. The table covers only an owner who qualifies for a solo 401(k), is 60 to 63 and takes W-2 pay. It is not a calculation for Gus's 40-employee company.

Beliefs that send owners out of order, and how Apollon Wealth Management checks them

"A bigger business contribution always saves tax." Not quite. Traditional contributions usually defer income tax, and later withdrawals are generally taxable, so the move shifts the tax cost across years. It saves money mainly when the later rate is lower.

"Gross sales set the limit." They don't. S corporation owners generally use W-2 compensation, while sole proprietors use the net-earnings calculation. An owner who sized a deposit from revenue may have put in more than the rules allow, and that gets corrected after the fact.

"A solo 401(k) is simply a better SEP." It often is, with no staff. But one eligible employee can make a solo arrangement unsuitable, even in a high-income year when the extra room looks irresistible. At Apollon Wealth Management, the census gets checked before anyone talks about the room.

Why an old plan assumption may no longer hold

A worksheet from a few years back may cap catch-up at $8,000. In 2026 an owner age 60 to 63 can add $11,250 in a 401(k), so the old sheet can understate room by $3,250. And if prior-year FICA wages exceeded $150,000, 2026 catch-up contributions must be Roth, which means no deduction now for that slice. Rerun the numbers when payroll changes, a spouse starts drawing pay, or the sale date moves.

Does marriage, account size or retirement date change the choice?

Yes, in three ways. A married couple needs separate pay records, because Deborah's contribution room exists only if she has eligible compensation. A $700,000 balance doesn't raise the annual limit. And an owner retiring soon should weigh today's deferral against likely taxable withdrawals more heavily.

Gus's SEP-IRA won't grow his room, but it makes future withdrawals matter. At 63, with a sale possibly closing in a year or two, he has to ask what the $700,000 plus new deferrals will add to taxable income in his first years out of the company. That's the number to compare with today's saving.

An owner ten years from retirement has more room to work with: more years of wages, more years of contributions, more flexibility if the sale price disappoints. Gus doesn't have that cushion, so his decision rests more on tax timing. Apollon Wealth Management usually lays both timelines on one page before any contribution is chosen.

Leave room for the year that does not go as planned

Gus and Deborah set aside cash for payroll, equipment and a possible sale delay before they fund any contribution. Retirement deposits don't replace working capital. Markets can fall, health can force early retirement and Congress can change tax rules; no return is certain, and investments can lose money. Apollon Wealth Management would separate eligibility from arithmetic first, then compare today's tax cost with the expected withdrawal years. Two steps you can do alone this week: count everyone on payroll and gather last year's W-2s.