Solo 401(k)s and SEP IRAs for Consultants, Contractors, and Side Businesses in 2026

Self-employment income opens the door to retirement contributions far larger than an employee's deferral limit. The two main vehicles differ in mechanics, paperwork, and who they suit.

A growing number of Bay Area professionals earn income outside a traditional paycheck: a laid-off engineer consulting between roles, a product manager advising startups on the side. That income carries a tax burden, since the self-employment tax of 15.3% applies on top of income tax up to the Social Security wage base and Medicare tax above it. It also carries an opportunity: self-employed individuals can establish their own retirement plans, with contribution limits considerably higher than most people expect.

The 2026 limits

The IRS caps total 2026 defined contribution plan additions for one person at $72,000, or $80,000 including the catch-up contribution for those 50 and older, and up to $83,250 for ages 60 to 63. Within that total, the employee elective deferral limit is $24,500, with an $8,000 catch-up at 50 and $11,250 at ages 60 through 63. The remainder comes from employer contributions, and a self-employed person is both.

SEP IRA

A simplified employee pension is the easier to set up. The business contributes up to 25% of compensation to a traditional IRA for each eligible participant, up to the annual dollar cap. There are no employee deferrals. The plan can be established and funded as late as the due date of the business return including extensions, which helps someone who discovers in March that last year was unexpectedly profitable. Roth SEP contributions are permitted if the plan document allows them, though not every custodian offers them.

The main limitation is that a SEP must cover eligible employees at the same percentage as the owner, which is irrelevant for a sole consultant but can become expensive for a small firm with staff. For self-employed owners the arithmetic is also less generous than 25% suggests, because compensation means net earnings after subtracting half of self-employment tax and the contribution itself, a Publication 560 calculation that works out to roughly 20% of net profit.

Solo 401(k)

A one-participant 401(k) is available to a business owner with no employees other than a spouse. It allows both the employee deferral and the employer contribution of up to 25% of compensation, subject to the same overall cap, which produces a larger contribution than a SEP at moderate income levels.

Consider a hypothetical consultant under 50 with $120,000 of net self-employment earnings after the self-employment tax adjustment. A SEP would allow roughly $24,000. A solo 401(k) would allow the $24,500 deferral plus roughly $24,000 as the employer, about $48,500. At high income levels the two converge at the $72,000 ceiling, but the solo 401(k) reaches it sooner.

Solo 401(k)s also commonly permit Roth deferrals, loans, and, depending on the plan document, after-tax contributions that can be converted to Roth, the mega backdoor mechanics discussed in a separate Insights article. The trade-offs are administrative. Adoption deadlines are stricter than for a SEP and differ for employee and employer contributions, and once assets reach $250,000 the plan must file Form 5500-EZ annually. Hiring a non-spouse employee generally ends eligibility and requires a full plan with coverage testing.

Coordination with a day job

Someone with a W-2 job and a side business must coordinate the two. The IRS states that the salary deferral limit is an individual limit each calendar year no matter how many plans you are in, so deferrals to an employer 401(k) reduce what can be deferred to a solo plan. Employer contributions based on side income may still be available to someone who has already maxed a day-job deferral, though how the overall cap applies depends on the relationship between the two businesses. A SEP, having no employee deferral component, is unaffected by the day-job deferral.

Other considerations

Contributions reduce federal and California taxable income, and California's top rates of 12.3% plus the 1% surcharge over $1 million make the deduction more valuable here than in most states. Self-employed Californians who do not pay into State Disability Insurance may also wish to look into the Employment Development Department's Disability Insurance Elective Coverage program. Contributions are locked until retirement age with limited exceptions, so a household should fund its emergency reserve and pay its estimated taxes first.

Both plans are inexpensive to open at most custodians, but a solo 401(k) with Roth or after-tax features may require a more sophisticated plan document, and errors in contribution calculations can trigger excise taxes.

This article is educational only and does not constitute investment, tax, or legal advice; readers should consult a qualified professional before establishing or funding a retirement plan.

Important Disclosures

Important Disclosures: Propulsion Capital Management is an investment adviser registered with the State of California Department of Financial Protection and Innovation. Registration does not imply a certain level of skill or training. This article is provided for general informational and educational purposes only and does not constitute investment, tax, legal, or accounting advice, nor an offer or solicitation to buy or sell any security or to adopt any particular investment strategy. The information is believed to be accurate as of the date of publication but is subject to change without notice; tax laws and regulations change frequently and their application depends on individual facts and circumstances. Nothing herein should be relied upon as a substitute for personalized advice from a qualified professional. Investing involves risk, including the possible loss of principal, and past performance is no guarantee of future results. Diversification does not ensure a profit or protect against loss. Any examples are hypothetical, are for illustrative purposes only, and do not reflect the experience of any client. Links to third-party websites are provided for convenience; Propulsion Capital Management does not endorse, and is not responsible for, the content of third-party sites. Propulsion Capital Management does not provide tax or legal advice; please consult your tax adviser or attorney regarding your specific situation.