Solo 401(k) vs. SEP IRA: The Right Answer for S-Corp Owners (It’s Usually Not the SEP)

Ask a brokerage which retirement plan to open and you’ll often get pointed to a SEP IRA — it takes ten minutes to set up. Ask what maximizes your contribution, your Roth options, and your flexibility as an S-corp owner, and the answer is usually the solo 401(k). The difference can be tens of thousands of dollars of tax-advantaged space per year.

The core math difference

Both plans allow employer contributions of up to 25% of your W-2 wages (for an S-corp owner). The solo 401(k) adds something the SEP doesn’t: an employee deferral — roughly the mid-$20,000s per year at current limits, plus a catch-up if you’re 50 or older.

Concrete example. S-corp owner, $100,000 W-2 salary:

•             SEP IRA: 25% × $100,000 = $25,000 total.

•             Solo 401(k): ~$24,500 employee deferral + $25,000 employer = ~$49,500 total.

Same salary, nearly double the sheltered amount — because the deferral stacks on top of the employer piece. To reach the same total with a SEP alone, you’d need roughly double the W-2 salary, which means paying substantially more payroll tax just to create contribution room. The solo 401(k) lets you run a leaner (still reasonable) salary and shelter more. This interaction between compensation strategy and plan choice is exactly why the two decisions should be made together.

Beyond the headline number

Roth flexibility. Solo 401(k)s can include a Roth deferral option. SEPs are traditional-only in practice for most providers.

The mega backdoor. A properly drafted solo 401(k) can permit after-tax contributions plus in-plan conversion — the “mega backdoor Roth” — pushing total annual additions toward the overall limit (around $70,000+, more with catch-ups). This requires the right plan document; the free brokerage prototype usually doesn’t support it.

Spousal doubling. If your spouse legitimately works in the business with W-2 wages, everything above can double across the household.

Loans. Solo 401(k)s can permit participant loans; SEPs cannot.

Backdoor Roth compatibility. SEP balances count in the pro-rata calculation that complicates backdoor Roth IRA contributions. Solo 401(k) balances don’t — and can even absorb old IRA money via rollover to clean up the pro-rata problem. For high earners doing annual backdoor Roths, this alone can decide the question.

Where the SEP still wins

Simplicity and deadline forgiveness. A SEP can be established and funded as late as the extended filing deadline for the prior year — it’s the classic “it’s March and I want a deduction for last year” tool. It also stays simpler if you have (or will hire) non-owner employees, where a solo 401(k) stops being “solo” and real plan design questions begin.

The deadline that catches people

Solo 401(k) employee deferral elections generally must be made by December 31, even though funding can follow later. Decide in March and you’ve forfeited the deferral for the prior year — you’re left with employer-only contributions, i.e., SEP math. This is a Q4 decision, full stop.

The decision in one line

Owner-only business, high savings goal, any interest in Roth strategy → solo 401(k), set up before year-end. Prior-year rescue mission or employees on payroll → SEP (or a broader plan conversation).

Romanchuk CPA LLC coordinates retirement plan strategy with S-corp compensation planning — the two decisions that only work when made together. Book a year-end session at rfg.tax.

This article is general information, not tax or investment advice for your specific situation. Contribution limits adjust annually — verify current figures.