Self-Employed Retirement Accounts Compared: SEP-IRA, Solo 401(k), and SIMPLE IRA

The three major retirement plan options for sole proprietors and freelancers—the SEP-IRA, the solo 401(k), and the SIMPLE IRA—offer different contribution limits, administrative requirements, and flexibility. Which one suits you depends on how much you want to save, how much administrative overhead you’ll tolerate, and whether you might hire employees.

SEP-IRA: Maximum contribution simplicity

A SEP-IRA (Simplified Employee Pension IRA) allows you to contribute up to 25% of your net self-employment income, capped at the annual limit. Because the percentage is based on your business income, higher earners can shelter more dollars. The setup is streamlined: you need only file a one-page IRS form (Form 5305-SEP) and open an IRA account with a custodian. No annual tax filings are required beyond what you’d do for your business.

The SEP’s weakness emerges if you hire employees. Once you sponsor a SEP, you must contribute the same percentage of salary to eligible employees’ SEP accounts as you contribute for yourself. If you earn $200,000 and contribute 20%, you must also contribute 20% of each employee’s salary. This can become expensive at scale.

The SEP also offers less flexibility once the year ends. You can’t take out a loan against your balance (unlike a 401(k)). Withdrawals before age 59½ incur a 10% penalty plus income tax. The contribution percentage is also fixed: you choose it at setup time, and while you can adjust it annually, you can’t change it mid-year in response to sudden income swings.

Solo 401(k): Maximum flexibility and borrowing power

A solo 401(k) (also called an individual 401(k)) is a full-featured retirement plan designed for self-employed people with no employees. It allows much larger contributions than a SEP if your income is high enough: you can contribute as both an employee (up to $23,500 in 2024) and employer (up to 25% of net profit). The combined limit is $69,000 annually, or $76,500 if you’re 50 or older and use the catch-up provision.

The solo 401(k)’s chief advantage is flexibility. You can take a loan against your balance (typically up to $50,000 or 50% of your account, whichever is smaller), providing emergency access without triggering tax and penalties. You can also choose to make contributions using profit-sharing or defer-compensation elections, letting you change the amount year to year based on business performance.

Setup is more involved than a SEP: you need a written plan document, an Employee Identification Number (EIN), and ongoing record-keeping. You must also file Form 5500 if your account balance exceeds $250,000 at year-end, creating additional accounting work. If you ever hire an employee, you generally must close the solo 401(k) and convert to a different plan structure, though “non-employee” family members in certain roles can be exceptions.

Solo 401(k)s are popular with high-income freelancers and small-business owners who value the flexibility and borrowing option over simplicity.

SIMPLE IRA: For small teams and minimal overhead

The SIMPLE IRA is designed for small businesses (under 100 employees). It sits between the SEP and the solo 401(k) in complexity and contribution limits. You can contribute up to $16,000 annually (plus $3,500 catch-up if 50+), significantly lower than the solo 401(k) or SEP for high earners. However, setup is straightforward, and annual compliance is minimal—you file one form with the IRS and maintain records, but no Form 5500 is required unless your account exceeds $250,000.

The SIMPLE’s defining feature is its employee requirement: if you have employees, you must offer the same plan to them and make mandatory contributions. Your employees can contribute up to the limit, and you must either match their contributions (up to 3% of salary) or contribute a fixed 2% of salary for all eligible employees. This makes the SIMPLE expensive if you have a team, but it’s also why it’s popular with very small businesses—the mandatory employer contribution is simpler to administer than a SEP’s percentage match.

If you’re a true sole proprietor with no plans to hire, the SIMPLE IRA offers fewer advantages over the SEP (lower limits, more compliance paperwork) but can be preferable if you want the simplicity of fixed employee requirements that won’t apply to you.

Choosing based on income level

For freelancers earning under $50,000 in net profit, all three plans work, though the SEP’s simplicity and the SIMPLE’s lower compliance burden are attractive. The contribution limits barely matter at lower income levels since you won’t hit the maximum anyway.

For those earning $50,000–$150,000, the choice tightens. A SEP still offers easy setup and high contribution room. A solo 401(k) costs more to set up but provides flexibility. A SIMPLE IRA may be overkill unless you have employees.

For high earners above $150,000, the solo 401(k) typically wins. The ability to contribute 25% of profits up to $69,000+ far exceeds what a SIMPLE IRA allows, and the contribution ceiling ($69,000) is often reached. If you truly have no employees and want zero administrative burden, a SEP still works but forces you to contribute 25% of every employee’s salary if you hire later.

SEP vs solo 401(k) for employees

If you run a solo business today but anticipate hiring in the future, the solo 401(k) and SEP diverge significantly. Converting a solo 401(k) to a full workplace plan is complicated but possible. Converting a SEP is simpler, but you’re locked into the 25% matching obligation from day one.

Some high-income freelancers with employees use a SEP and separately max out a traditional IRA or Roth IRA to reduce the sting of mandatory employee contributions. Consulting with a tax professional is worthwhile if your income or hiring plans change materially.

Tax deductibility and net income

All three plans allow deductions from your business income. A SEP or SIMPLE contribution directly reduces your self-employment income, lowering both income tax and self-employment tax. Solo 401(k) employee deferrals work the same way. Employer contributions in all three reduce income tax but not self-employment tax.

One common mistake: calculating the deductible contribution on gross business income rather than net profit. The SEP, solo 401(k), and SIMPLE all base contributions on net self-employment earnings after deducting half of your self-employment tax. This circular dependency requires a worksheet to compute correctly—most tax software handles it automatically, but manual calculation often overstates the allowable amount.

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