Retirement Plans for the Self-Employed

Nobody sets up a 401(k) for a freelancer. The upside is that the self-employed have access to shelters an employee cannot touch, and can often put away far more than a corporate salary allows. This guide compares the four real options and works the contribution math at four income levels.

By Karanvir Singh, founder of Quantix Invest

The landscape in one table

All dollar figures below use 2026 amounts and are indexed annually. Verify the current-year limits before you contribute.

The short version for most readers: a solo 401(k) if you have no employees, a SEP-IRA if you value simplicity above all, a SIMPLE IRA if you have staff and a modest budget, and a defined benefit plan only at high and reliable income. The rest of this guide explains why, and shows where the differences actually bite.

What counts as your compensation

Every contribution formula runs off a compensation number, and the self-employed number is not your revenue and not your Schedule C profit. Getting this right is most of the work.

For a sole proprietor, partner, or single-member LLC taxed as a sole proprietorship, the figure is net earnings from self-employment:

1. Start with net profit from Schedule C (revenue minus business expenses).
2. Multiply by 0.9235. This removes the employer half of self-employment tax from the base.
3. Compute self-employment tax on that amount (12.4% Social Security up to the wage base, plus 2.9% Medicare with no cap, plus the additional Medicare tax at higher incomes).
4. Subtract half of the self-employment tax from the step-1 profit. The result is your net earnings for plan purposes.

Then one more twist for the employer profit-sharing piece. The statutory rate is 25% of compensation, but for the self-employed the contribution itself reduces the compensation it is based on, so the effective rate becomes 20% of net earnings. That 20% figure is where the well-known shortcut comes from, and it is why so many people who assume "25% of profit" end up over-contributing.

If your business is an S corporation, the math is different and simpler: the plan runs off your W-2 wages only. Distributions do not count. This creates a real tension, since S-corp owners often minimize wages to reduce payroll tax, and doing so directly shrinks how much they can shelter.

The solo 401(k)

Also called an individual 401(k) or one-participant 401(k). It is a real 401(k) plan with exactly one participant (or two, if your spouse works in the business). Because you are both the employee and the employer, you contribute in both capacities.

• As employee: up to the standard deferral limit, roughly $24,000 in 2026, plus a catch-up of about $8,000 at age 50 and older, with a higher catch-up in the 60 to 63 window under SECURE 2.0. This can be pre-tax or Roth if the plan offers Roth. Crucially this is a flat dollar amount, not a percentage, so even modest income can fund it.
• As employer: up to 20% of net earnings (25% of W-2 wages for an S corp), always pre-tax historically, though SECURE 2.0 now permits Roth employer contributions where a plan supports them.
• Combined cap: the section 415(c) limit, roughly $72,000 in 2026, plus catch-up contributions on top. Compensation counted for the employer piece is itself capped, around $360,000.

Other advantages worth knowing:

• It does not count in the IRA pro-rata pot. This is the quiet feature that makes solo 401(k)s valuable to anyone doing a backdoor Roth. A SEP or SIMPLE balance poisons that strategy; a solo 401(k) does not.
• It can accept incoming rollovers. That means you can roll an old pre-tax IRA into it, emptying the pro-rata pot in the process.
• Roth availability. Many providers now offer a Roth solo 401(k), letting you split deferrals between pre-tax and Roth.
• Loans. Some providers permit plan loans, generally up to the lesser of $50,000 or half the balance. Useful in an emergency, though borrowing from retirement money is rarely the best answer.

The costs: you need a written plan document (mainstream brokerages provide a free prototype), and once total plan assets exceed $250,000 you must file Form 5500-EZ annually. That form is short, but the penalty for ignoring it is not, so put it on the calendar. If you hire a non-spouse employee who meets the eligibility rules, the plan stops being a one-participant plan and becomes a full 401(k) with testing and compliance obligations.

The SEP-IRA

A Simplified Employee Pension IRA is what it sounds like: an IRA that an employer funds. Setup takes minutes, there is no annual filing, and every major brokerage offers one for free.

• Employer contributions only. No employee deferral. This is the decisive limitation.
• Up to 25% of compensation (effectively 20% of net earnings for the self-employed), to a cap around $72,000.
• Deadline is generous: you can establish and fund a SEP up to your tax filing deadline including extensions, which is why it is the classic October rescue plan for someone who forgot to set anything up.
• Traditional pre-tax only at nearly all custodians, despite SECURE 2.0 permitting Roth SEPs in principle.

Two things disqualify it for many people. First, without the employee deferral, a SEP contributes far less at low and moderate income; see the math section. Second, a SEP-IRA balance counts in the pro-rata pot for backdoor Roth purposes, which can quietly cost a high earner thousands.

The other constraint appears when you have staff. A SEP requires the same contribution percentage for every eligible employee, including you. Contribute 20% for yourself and you must contribute 20% of pay for each eligible employee, and those contributions are immediately 100% vested. With several employees this becomes expensive fast.

The SIMPLE IRA

A Savings Incentive Match Plan for Employees is designed for small businesses with up to 100 employees that want to offer something without 401(k) administration costs.

• Employee deferral of roughly $17,000 in 2026, with a catch-up around $4,000 at 50 and older, and higher deferral limits available for very small employers under SECURE 2.0.
• Mandatory employer contribution, either a dollar-for-dollar match up to 3% of pay, or a 2% nonelective contribution for every eligible employee whether or not they defer.
• Roth SIMPLE contributions are now permitted where the provider supports them.
• Must be established by October 1 for the current year, and you cannot maintain another plan simultaneously.

Two sharp edges. The early withdrawal penalty is 25%, not the usual 10%, on distributions in the first two years of participation. And a SIMPLE IRA balance also counts in the backdoor Roth pro-rata pot.

For a solo operator, a SIMPLE IRA is almost always the wrong choice: it caps you far below what a solo 401(k) would allow. Its niche is a small business with employees where a 401(k) feels like too much administration and the owner wants a low, predictable staff cost.

Contribution math at four income levels

All examples use a sole proprietor under 50, filing a Schedule C, with no employees. Figures are rounded and use approximate 2026 limits; treat them as illustration of the mechanics rather than exact tax computation.

Case 1: $50,000 of net profit.

• Net earnings after the self-employment tax adjustment: roughly $46,200.
• SEP-IRA: 20% of $46,200 = $9,240. That is the whole plan.
• Solo 401(k): employee deferral up to $24,000, but capped at earned income; plus employer 20% of $46,200 = $9,240. Total available is roughly $46,200, so realistically the constraint is cash flow, not the plan. Contributing $24,000 as an employee deferral plus $9,240 as employer gives $33,240 of shelter, more than three times the SEP.

This is the clearest demonstration of the difference. At modest income, the employee deferral does nearly all the work, and the SEP has none.

Case 2: $120,000 of net profit.

• Net earnings: roughly $110,800.
• SEP-IRA: 20% of $110,800 = $22,160.
• Solo 401(k): $24,000 deferral plus $22,160 employer = $46,160.
• Advantage to the solo 401(k): $24,000 of additional shelter in a single year. At a combined 32% marginal rate, that is roughly $7,700 of deferred tax.

Case 3: $250,000 of net profit.

• Net earnings: roughly $232,000 (the Social Security portion of self-employment tax stops at the wage base, so the adjustment shrinks proportionally at higher incomes).
• SEP-IRA: 20% of $232,000 = $46,400.
• Solo 401(k): $24,000 plus $46,400 = $70,400, just under the roughly $72,000 overall cap, so about $70,400.
• Advantage to the solo 401(k): still roughly $24,000.

Case 4: $400,000 of net profit.

• Net earnings are high enough that the 20% employer calculation alone reaches the cap, subject to the compensation limit of about $360,000.
• SEP-IRA: hits the overall cap, roughly $72,000.
• Solo 401(k): also caps at roughly $72,000 (plus catch-up if 50 or older, which the SEP does not offer).
• The plans finally tie on dollars. The solo 401(k) still wins on Roth availability, loans, catch-up contributions, and staying out of the backdoor Roth pro-rata pot.

What changes when you hire someone

Every plan on this page has a different answer to "what if I have employees," and this is usually the deciding factor once a business grows past one person.

• Solo 401(k): works only with you and your spouse. Once a non-spouse employee becomes eligible (generally after a year of service at 1,000 hours, or under SECURE 2.0's long-term part-time rules after two consecutive years at 500 hours), the plan must convert to a regular 401(k) with nondiscrimination testing, a plan administrator, and real cost. Plan the transition before the employee becomes eligible, not after.
• SEP-IRA: every eligible employee gets the same percentage you give yourself, fully vested immediately. Eligibility can be set at up to age 21, three of the last five years of service, and a low minimum compensation threshold, which lets you exclude short-tenured and very part-time staff.
• SIMPLE IRA: mandatory match up to 3% of pay or a 2% nonelective contribution. Predictable and modest, which is the point.
• Full 401(k) with safe harbor: once you have several employees and want to max your own contribution, a safe harbor 401(k) (typically a 4% match or 3% nonelective) bypasses nondiscrimination testing. Administration runs somewhere in the low thousands per year, and SECURE 2.0 startup tax credits can offset a meaningful share of the cost for small employers in the first few years.

Defined benefit and cash balance plans

Everything above is a defined contribution plan: you put money in, and whatever it becomes is what you get. A defined benefit plan works backward. It promises a specific annual pension at retirement, and an actuary calculates each year what must be contributed to fund that promise. Because the promise is fixed, contributions can be enormous, and they are deductible business expenses.

A cash balance plan is the modern version: technically a defined benefit plan, but each participant sees a hypothetical account balance credited with a pay credit plus an interest crediting rate, which is easier to understand and more portable.

The mechanics that make contributions large: the annual benefit that may be funded is capped at a figure around $290,000 per year at retirement, and the closer you are to retirement age, the fewer years remain to fund it, so the required annual contribution is bigger. A 55-year-old can often contribute two to three times what a 40-year-old can.

Illustrative example. A 55-year-old consultant with $500,000 of consistent net profit and no employees sets up a cash balance plan alongside a solo 401(k). A plausible design allows roughly $180,000 into the cash balance plan plus roughly $40,000 through the paired 401(k) profit sharing and deferral, sheltering somewhere near $220,000 in one year. At a combined federal and state marginal rate around 45%, that is nearly $99,000 of tax deferred in a single year. Actual numbers depend entirely on the actuarial design, age, and census.

The costs and constraints are serious, and this is where the skepticism belongs:

• Real fees. Actuarial and administration costs typically run $2,000 to $5,000 or more per year, every year the plan exists.
• Contributions are largely mandatory. This is the big one. A defined benefit plan is a funding obligation, not an option. A bad year does not excuse you, and chronic underfunding creates excise taxes. Only businesses with genuinely stable, high income should consider one.
• Employees must be covered and the benefits they receive are meaningful, not token. Coverage and nondiscrimination testing governs the design.
• Investment returns matter in reverse. If plan assets underperform the assumed crediting rate, you must contribute more to make up the gap. If they overperform, your allowed contributions shrink. This normally pushes toward a conservative portfolio inside the plan.
• Terminating a plan requires an orderly wind-down and rollover, and the IRS expects a plan to be intended as permanent, generally meaning at least several years.

The honest summary: a defined benefit plan is a powerful tool for a narrow group, roughly an owner over 45 with more than $300,000 of durable annual profit, few or no employees, and the ability to commit for years. For everyone else it is an expensive way to buy complexity.

Interaction with the backdoor Roth

This deserves its own section because it silently decides plan choice for a lot of high earners.

The backdoor Roth requires that your total balance across all traditional, SEP and SIMPLE IRAs be zero at year end, or the pro-rata rule makes most of your conversion taxable. A solo 401(k) balance does not count in that pot. Neither does a defined benefit plan.

Worked example. Dana, a freelance designer earning $200,000, has been contributing to a SEP-IRA for six years and has accumulated $180,000 in it. She now wants to do a backdoor Roth with a $7,000 nondeductible contribution.

• Total IRA pot including the conversion: $180,000 + $7,000 = $187,000.
• After-tax basis: $7,000. Nontaxable fraction: 7,000 / 187,000 = 3.74%.
• Tax-free portion of her $7,000 conversion: $262. Taxable portion: $6,738.
• At a 32% federal and 5% state rate, tax owed: roughly $2,493 on a move she expected to be free.

The fix: open a solo 401(k), confirm it accepts incoming rollovers (not all prototype documents do, so check before opening), roll the entire SEP-IRA balance into it, and make future employer contributions there instead. Once the SEP is empty at December 31, the pro-rata pot is clear and the backdoor Roth is free again.

That single interaction is often worth more than any contribution-limit difference, and it is the strongest argument for choosing a solo 401(k) from the start.

Deadlines, paperwork, and where to open one

Where to open one: the major discount brokerages all offer free solo 401(k) and SEP-IRA plans with no setup or maintenance fee and access to broad low-cost index funds. Third-party administrators charge a few hundred dollars a year and exist for a reason: they provide custom plan documents supporting features prototype plans lack, such as Roth deferrals, in-plan conversions, after-tax contributions for a mega backdoor Roth, and loans. Pay for a custom document only if you will actually use those features.

What you should refuse to pay for: high-expense-ratio funds inside the plan, asset-based fees on a one-participant plan, and insurance products presented as retirement plans. The plan wrapper is the tax benefit. The investments inside it should be the same cheap, diversified funds you would own anywhere else.

Common mistakes

• Using 25% instead of 20% of net earnings. The classic over-contribution error for sole proprietors, and correcting an excess contribution is tedious and can carry a 10% excise tax.
• Basing contributions on revenue rather than net earnings. Expenses and half the self-employment tax come out first.
• Choosing a SEP by default. Simple to open, and usually leaves roughly $24,000 a year of shelter unused compared with a solo 401(k).
• Letting a SEP or SIMPLE balance sit while doing a backdoor Roth. Check the pro-rata pot every December.
• S-corp owners setting wages too low. Payroll tax savings can cost you more in lost plan capacity than they save.
• Missing the Form 5500-EZ filing once solo 401(k) assets pass $250,000. Easy to file, expensive to forget.
• Missing the October 1 SIMPLE deadline and losing the year.
• Forgetting the deferral election timing. Employer contributions can be made later, but the employee deferral election generally must be in place before the plan year ends.
• Hiring an employee without revisiting the plan. A solo 401(k) with an eligible non-spouse employee is a compliance problem, not a plan.
• Committing to a defined benefit plan on one great year. The contributions are largely mandatory going forward. Fund it from income you are confident will repeat.
• Deferring at all costs. If you are in a low bracket this year, Roth contributions inside the solo 401(k) may beat a deduction you barely need. Pre-tax is not automatically better.

Bottom line: for most self-employed people with no employees, a solo 401(k) is the answer, and the SEP-IRA is the fallback when you need something opened and funded before a filing deadline. Add employees and the calculus shifts toward a SIMPLE or a safe harbor 401(k). Reserve defined benefit plans for high, durable income where the mandatory contribution is genuinely affordable. This is education, not individualized advice, and plan selection is one of the places where a few hours with a qualified tax professional usually pays for itself.