For a W-2 employee, a 401(k) contribution lowers taxable wages. For the self-employed, a retirement contribution does something even more powerful: it lowers your Adjusted Gross Income (AGI), which in turn lowers the base on which your self-employment tax is computed, reduces the income tax you owe, can preserve more of your Qualified Business Income (QBI) deduction, and even lowers your modified AGI for the 3.8% NIIT test. In other words, the same dollar of contribution can save you tax in three or four different places at once. That is why maximizing a Solo 401(k) or SEP IRA is usually the single highest-leverage move a profitable freelancer can make.
SEP IRA — The Worked Example
A SEP IRA lets you contribute as the employer. The deductible amount is generally up to 25% of your net business profit (more precisely, 20% of your net earnings from self-employment after subtracting the one-half SE tax deduction). Because the contribution itself is deducted, it is a classic "above-the-line" adjustment that reduces AGI directly.
Worked Example — SEP IRA on $80,000 net profit
Net profit: $80,000
Simple SEP rule: 25% × $80,000 = $20,000 deductible contribution.
(The exact IRS figure is slightly lower — about 20% of net earnings from self-employment, which removes the one-half SE tax deduction — but $20,000 is the easy planning estimate.)
Tax effect: that $20,000 is not counted in AGI, so you skip income tax on it and also shrink the SE-tax base. In the 22% federal bracket that is roughly $4,400 of income-tax saved, plus SE-tax savings and any state savings.
Solo 401(k) — Two Buckets in One Plan
A Solo 401(k) (also called an Individual 401(k)) is available when you have no full-time employees other than a spouse. It lets you contribute in two roles:
- Employee deferral: up to $24,500 for the year (or $30,500 if age 50 or older, the "catch-up" amount).
- Employer profit-sharing contribution: up to 25% of net profit (the same logic as the SEP), which stacks on top of the employee deferral.
The combined total cannot exceed the annual defined-contribution cap (about $72,000, or $76,500 with the age-50 catch-up). The Solo 401(k) overtakes the SEP once your profit is large enough that the employee deferral adds meaningful value, and it is the only one of the three that offers a Roth sub-account.
Worked Example — Solo 401(k) on $80,000 net profit, under age 50
Employee deferral: $24,500
Employer 25% of net profit: $20,000
Total deductible: $43,000 (well under the overall cap).
Compared with the SEP alone ($20,000), the Solo 401(k) lets this person shelter an extra $24,500 by using the employee deferral — a huge difference for the same profit level.
SIMPLE IRA — When You Have Employees
If you have employees, a SIMPLE IRA is often the practical choice because it is designed for businesses with staff. As the employer you must either match employee deferrals up to 3% of compensation or make a 2% nonelective contribution for every eligible employee. The employee can defer up to $16,000 (or $19,500 at age 50+). The SIMPLE IRA is simpler to administer than a full 401(k) but has a lower ceiling and a mandatory 2-year waiting rule before rollovers in some cases, so it suits smaller teams.
Side-by-Side Comparison
The Contribution Base Subtlety (So You Are Not Surprised)
The "25% of net profit" number is the easy planning estimate. The IRS actually computes the employer piece as 20% of your net earnings from self-employment, where net earnings are your profit minus one-half of your SE tax. Because of that subtraction, the true maximum is a few hundred to a few thousand dollars below the straight 25% figure, depending on profit. It rarely changes the planning decision, but if you are contributing right up to the cap, run the exact Schedule SE math (or use our calculator) so you do not over-contribute, which the IRS would require you to correct.
Traditional vs. Roth
A SEP IRA is always pre-tax: you deduct now and pay tax on withdrawals in retirement. A Solo 401(k) can hold a Roth sub-account for the employee deferral portion, meaning you contribute after-tax dollars now but enjoy tax-free withdrawals later. SEP and SIMPLE employer contributions are pre-tax only. Choosing Roth vs. traditional depends on whether you expect to be in a higher or lower bracket in retirement; many young freelancers with low current income favor Roth, while high earners near their peak often favor traditional for the immediate deduction.
Deadlines and the Extension Trick
You can make SEP IRA and Solo 401(k) contributions up to your tax filing deadline, including extensions. For the 2026 tax year that means you have until April 15, 2027, or October 15, 2027 if you file an extension, to fund the prior year's contribution. This is a rare and valuable feature: you can see your full-year numbers before deciding how much to shelter. SIMPLE IRA employee deferrals, by contrast, must generally be made by year-end (December 31). Note you must have the Solo 401(k) plan established by December 31 to contribute for that year, even though the dollars can go in later.
Catch-Up Contributions
Once you turn 50, the IRS lets you contribute extra. For the employee deferral, the catch-up adds $7,500 to the Solo 401(k) and SIMPLE IRA limits (so $30,500 and $19,500 respectively). There is also a special higher catch-up for ages 60–63 in some recent law changes for workplace plans, but the standard $7,500 applies broadly. Catch-ups are a major advantage for freelancers who got a late start on retirement savings.
Common Mistakes
- Leaving the deduction on the table. Many new freelancers never open a plan and pay full tax on profit they could have sheltered.
- Thinking SEP and Solo 401(k) stack. You cannot contribute to both on the same net profit; you pick one plan (you may, however, have a SEP for one business and a Solo 401(k) for another, subject to aggregation rules).
- Over-contributing. Using the 25% shortcut without the SE-tax subtraction can push you slightly over the legal max; correct excess contributions before the filing deadline to avoid a 6% excise tax.
- Forgetting the Solo 401(k) must be opened by Dec 31. The money can arrive later, but the plan must exist by year-end.
- Ignoring the QBI interaction. A larger retirement deduction lowers taxable income, which can increase your QBI deduction if you were near a phase-out — a second layer of savings.
- Missing state benefits. Most states with an income tax also let you deduct these contributions, so the state-side savings are real too.
How This Connects to Your Other Taxes
Because a retirement contribution lowers your net earnings, it directly reduces the Self-Employment Tax you owe and can pull high earners back under the Additional Medicare Tax thresholds. It also shrinks the total that feeds your quarterly estimated payments, so funding a plan in Q1 can lower the remaining three payments. If you operate as an S-Corporation, you can still run a Solo 401(k) as the plan sponsor and contribute both as employee (on salary) and as employer (on salary). Gig workers on Uber or Upwork should first compute net profit, then decide how much of it to shelter here.