Side income comes with an expensive tax bill and one genuinely large consolation. It opens retirement accounts that employees cannot use, and they shelter far more than the $7,500 an IRA allows.
Two are worth considering: the Solo 401(k) and the SEP IRA. Both top out at $72,000 for 2026. They reach it by completely different routes, and on modest side income the difference between them is enormous.
How each one is filled
This is the whole comparison, and everything else follows from it.
A SEP IRA takes employer money only. You contribute as the business, and the limit is a percentage: 25% of compensation, which works out at about 20% of your net self-employment earnings once you are a sole proprietor. No percentage, no contribution.
A Solo 401(k) takes both. You contribute as the employee, up to $24,500 for 2026, and that part is not a percentage of anything. Then you contribute again as the employer, on the same roughly 20% basis. The two stack.
On a large profit both reach the same $72,000 cap. On a small one they are not remotely comparable, because the employee deferral does not shrink with your income the way a percentage does.
What each allows on $20,000 of profit
Take $20,000 of net profit from freelancing.
The SEP gives you roughly 20% of net earnings, so somewhere around $3,700. That is the whole allowance. It is not nothing, and it is less than you could put in an ordinary IRA.
The Solo 401(k) lets you defer as the employee first. Your deferral is capped at your earned income, so on $20,000 of profit you can put in most of it, and then add the employer contribution of around $3,700 on top. You can shelter something close to the entire profit.
That is not a marginal difference. On modest side income the Solo 401(k) shelters several times what a SEP does, and the gap only closes once profit gets large enough for the 20% employer piece to reach the cap on its own, which takes well over $300,000.
For almost everybody with a side business rather than a full-time one, this is the deciding fact.
Your day job uses the same deferral limit
The $24,500 employee deferral limit belongs to you, not to the plan. It is a single annual allowance across every 401(k) and 403(b) you participate in. If your day job's 401(k) has already taken the full $24,500, you have none of it left for your Solo 401(k).
Which removes the entire advantage. With the deferral used up, your Solo 401(k) can only take the employer contribution, which is the same roughly 20% a SEP would have given you. The two plans become functionally equivalent on the amount they shelter.
So the answer turns on one question about your day job.
| Your situation | Solo 401(k) | SEP IRA | Which shelters more |
|---|---|---|---|
| No job, or a job with no 401(k) | Deferral plus employer | Employer only | Solo, by a wide margin |
| Job 401(k), contributing a little | Remaining deferral plus employer | Employer only | Solo, by whatever deferral is left |
| Job 401(k), already maxed | Employer only | Employer only | The same |
Note what the employer contribution is not affected by. It is a business contribution, calculated from your self-employment income, and it is entirely separate from anything your employer's plan has done. Somebody maxing out at work can still put roughly 20% of their side profit into either account.
Why a SEP IRA blocks the backdoor Roth
If your day-job deferral is gone and both plans shelter the same amount, there is still a strong argument for the Solo 401(k), and it has nothing to do with limits.
A SEP IRA poisons the backdoor Roth. If your income is too high to contribute to a Roth IRA directly, the standard route is to contribute to a traditional IRA and convert. That works cleanly only if you hold no other pre-tax IRA money, because the tax on a conversion is worked out pro rata across all of your traditional, SEP and SIMPLE IRA balances combined.
A SEP IRA is an IRA. Its balance counts. Open one with $30,000 in it and every future backdoor Roth conversion becomes mostly taxable.
A Solo 401(k) is not an IRA and is invisible to that calculation. You can hold $200,000 in one and still do a clean backdoor Roth every year.
For a high earner who is already using the backdoor Roth, this single point outweighs everything else on this page.
Three smaller advantages, all going the same way. A Solo 401(k) can accept Roth contributions, so you can choose tax-free growth instead of a deduction. It can lend you money, up to half the balance or $50,000. And it can receive rollovers from old 401(k)s, which incidentally is another way to clear pre-tax IRA money out of the way of a backdoor Roth.
Where the SEP is the better answer
Three real cases, because the Solo 401(k) is not always right.
You are reading this in March, about last year. A SEP can be opened and funded right up to your filing deadline including extensions, so it can reduce a tax bill for a year that has already finished. That is a genuinely useful escape hatch and the Solo 401(k) does not fully offer it: the employer contribution has similar flexibility, but employee deferrals depend on the plan existing and an election being made, with only a narrow allowance for a sole proprietor's first plan year. If you want to shelter last year's profit and have no plan open, the SEP is usually the answer.
You have employees. A Solo 401(k) is only for a business with no employees other than you and your spouse. Hire anybody eligible and the plan has to become a real 401(k), with testing and administration. A SEP handles employees, though it requires you to contribute the same percentage for them as for yourself, which gets expensive quickly.
You want the least possible paperwork. A SEP is close to opening an ordinary brokerage account. A Solo 401(k) needs a plan document and, once assets pass $250,000, an annual Form 5500-EZ. It is not onerous, but it is more than nothing.
What a contribution saves you in tax
A contribution reduces your income tax, not your self-employment tax.
Self-employment tax is charged on your net earnings before any retirement contribution. Putting $18,000 into a Solo 401(k) does not reduce the 15.3% at all. What it reduces is the income the tax brackets are applied to.
So for somebody in the 22% bracket, an $18,000 contribution is worth around $3,960 in federal tax this year, plus whatever your state charges, and the money is invested rather than spent. A Roth contribution reverses that trade: no deduction now, nothing taxable later.
How to decide, in order
Do you have employees? If yes, the Solo 401(k) is out and this is a different conversation.
Are you trying to shelter a year that has already ended? If yes, and you have no plan open, a SEP is the practical choice.
Does your day job already take the full $24,500 deferral? If no, the Solo 401(k) shelters far more and the decision is made.
If yes, do you use the backdoor Roth? If you do, still take the Solo 401(k), because a SEP balance would compromise it. If you do not, either works and the SEP is simpler.
Where this fits with everything else
For the tax these contributions are reducing, and a calculator for what side income costs you before any of this, see side hustle taxes. For when that tax has to be paid, quarterly estimated taxes.
Our fuller guides to each account cover the mechanics: the Solo 401(k) and the SEP IRA. For how these sit against everything else available, tax advantaged retirement accounts sets out the order most people should fill them in.
And if you are still choosing what the side income should be, 25 ways to earn money from home and online covers the options.
Sources
The 2026 contribution limits come from the IRS announcement of the 2026 retirement plan limits. The rules for each plan are in the IRS page on one-participant 401(k) plans and the SEP FAQs.
Frequently asked questions
Which shelters more, a Solo 401(k) or a SEP IRA?
On modest side income, the Solo 401(k), usually by several times, because its employee deferral is not a percentage of profit. Once your day job's 401(k) has used your full $24,500 deferral, the two shelter the same amount.
Can I have a Solo 401(k) and a 401(k) at work?
Yes. The employee deferral limit of $24,500 is shared across both, but the employer contribution from your business is separate and unaffected by what your job's plan does.
How much can I contribute on $30,000 of side profit?
Roughly $5,600 to a SEP, being about 20% of net earnings. With a Solo 401(k) and an unused deferral, close to the whole $30,000. With the deferral already used at work, about the same as the SEP.
Does a retirement contribution reduce self-employment tax?
No. Self-employment tax is charged on net earnings before any contribution. It reduces income tax only.
Can I still open one for last year?
A SEP can be opened and funded up to your filing deadline including extensions. A Solo 401(k) is less flexible, particularly for employee deferrals, so if the year has ended and you have no plan, the SEP is usually the workable option.
Why does a SEP interfere with a backdoor Roth?
Conversions are taxed pro rata across all your traditional, SEP and SIMPLE IRA balances. A SEP balance makes each conversion mostly taxable. A Solo 401(k) is not an IRA and is ignored by that calculation.
What if I hire someone?
A Solo 401(k) only works with no employees besides you and a spouse. Taking on an eligible employee means converting to a full 401(k) with testing and administration, or moving to a SEP, which requires contributing the same percentage for them as for yourself.