Solo 401(k) vs. SEP IRA for California Owners

Self-employed people in California ask this question every spring, usually a few weeks before their CPA needs an answer. The choice is less about which plan is “better” and more about three facts: how much you earn, whether you’ll hire anyone, and how much paperwork you’re willing to carry.

I’m an estate planning and business attorney, not a financial advisor or CPA, and I don’t recommend plan providers or investments. What I can do is lay out the federal rules, show how California treats them, and point out where the plan you pick touches your estate plan, because a retirement account is often the second largest asset a business owner leaves behind.

What’s the difference between a solo 401(k) and a SEP IRA?

A solo 401(k) lets you contribute in two roles, and a SEP lets you contribute in one. The IRS describes the one-participant 401(k) as a traditional 401(k) covering a business owner with no employees, or the owner and a spouse, where the owner wears two hats: employee and employer. A SEP is an employer contribution to a traditional IRA, called a SEP IRA, set up for each eligible person.

	Solo 401(k)	SEP IRA
Who it fits	Owner with no employees, plus a spouse	Any business, with or without employees
Employee deferral (2026)	Up to $24,500, or 100% of compensation if less	None
Employer contribution	Up to 25% of compensation (20% of net self-employment earnings for a sole proprietor)	Same
Total cap (2026)	$72,000, not counting catch-up	$72,000
Catch-up (2026)	$8,000 at age 50, or $11,250 at ages 60 to 63	None
Roth option	Yes, designated Roth account	Yes, Roth SEP IRA, if the plan allows it
Loans	Allowed if the plan permits	Not allowed
Deadline to set up	By the return due date, including extensions, with a first-year limit on deferrals	By the return due date, including extensions
Annual IRS filing	Form 5500-EZ once plan assets exceed $250,000	Generally none

The dollar limits come from the IRS’s 2026 cost-of-living table. The compensation that counts toward either plan is capped at $360,000 for 2026, and the SEP minimum compensation for an eligible employee is $800.

How much can I contribute to each plan?

At most incomes below the cap, more to the solo 401(k). The employer contribution is the same in both plans. The solo 401(k) adds the employee deferral on top, and that’s the whole difference.

For a sole proprietor or single-member LLC, “compensation” means net earnings from self-employment after subtracting half of your self-employment tax and the plan contribution itself. That circular math is why the IRS’s Publication 560 says the 25 percent limit becomes 20 percent of your net earnings from self-employment when you’re contributing for yourself, and gives a rate table and worksheet to compute it.

Example 1: a sole proprietor earning $150,000

Lena is a 45-year-old graphic designer in Thousand Oaks with $150,000 of net profit on Schedule C and no employees. Her self-employment tax is about $21,194 (15.3 percent of 92.35 percent of her profit), so half of it, $10,597, comes off first. That leaves $139,403 of net earnings.

• SEP IRA: 20 percent of $139,403, or about $27,881.
• Solo 401(k): the same $27,881 employer contribution, plus a $24,500 employee deferral, for about $52,381.

At 50, Lena could add the $8,000 catch-up to the solo 401(k). If she turned 60 in 2026, the catch-up would be $11,250 instead. The SEP has no deferral to catch up on.

Example 2: a lower-income year

Now say Lena’s profit is $40,000. Half her self-employment tax is about $2,826, so her net earnings are about $37,174. The SEP allows 20 percent of that, about $7,435. The solo 401(k) allows the same $7,435 plus an employee deferral of up to 100 percent of compensation, capped at $24,500, for about $31,935. In a lean year, the solo 401(k) can shelter four times as much.

Example 3: an S corporation owner

If you own an S corporation, your compensation for either plan is your W-2 salary from the corporation, not the company’s profit. Sam’s S corporation pays him an $80,000 salary. A SEP allows 25 percent of that, $20,000. A solo 401(k) allows the same $20,000 employer contribution plus a $24,500 deferral withheld from his paychecks, for $44,500. The salary you set drives the retirement contribution as well as the payroll tax, which I cover in S corp reasonable salary for California owners.

When do the two plans come out even?

At high incomes, the 2026 cap of $72,000 binds both plans. By my math on the IRS worksheet, a sole proprietor’s SEP reaches the $72,000 cap at roughly $376,000 of net profit. At $376,000, self-employment tax is about $32,948 (Social Security tax stops at the $184,500 wage base for 2026), half of it is about $16,474, net earnings are about $359,526, and 20 percent of that is about $71,905. Above that, both plans allow $72,000, and the only difference left is the solo 401(k)’s catch-up. Your CPA should run your actual numbers.

What are the deadlines?

The SEP is the more forgiving plan on timing. The IRS says you can set up a SEP for a year as late as the due date, including extensions, of your business’s income tax return for that year, and the contributions are due by that same date.

A solo 401(k) can also be adopted after year-end. Under 26 U.S.C. § 401(b)(2), an employer that adopts a plan after the close of the tax year but before the return’s due date, including extensions, can elect to treat it as adopted on the last day of the year. For the first plan year, there’s a catch on the employee deferral.

That same subsection lets an owner of an unincorporated business who is the only employee make first-year deferrals before the due date of the owner’s individual return, determined without extensions, and treat them as made by year-end. For a calendar-year sole proprietor, that means the deferral for a new plan has to be in by mid-April, even if you extend. The employer contribution can wait for the extended deadline. An S corporation owner’s deferrals come out of salary, so they have to run through payroll during the year.

How does California tax a solo 401(k) or SEP?

The same way the IRS does, with one extra tax on early withdrawals. The FTB’s Publication 1005 says California conforms to the Internal Revenue Code provisions on pension plans and deferred compensation, including amendments enacted in the future, and that California’s SEP deduction has been the same as the federal deduction since 1996. Its 2026 table shows the same $24,500 401(k) deferral limit and the same $72,000 SEP and Keogh limits.

Publication 1005 also says California generally conforms to the retirement changes in the SECURE 2.0 Act, including the higher catch-up for ages 60 to 63. SB 711, enacted October 1, 2025, moved California’s general conformity date to the Internal Revenue Code from January 1, 2015 to January 1, 2025, according to the FTB’s conformity page. There’s no separate California contribution limit to track.

What about early withdrawals?

California adds its own tax. Publication 1005 says California’s tax on early distributions from IRAs and qualified plans generally follows the federal rule, but at 2.5 percent. It’s in addition to the federal 10 percent additional tax on withdrawals before age 59½ that the IRS describes for SEP IRAs. A $20,000 early withdrawal can cost $2,000 in federal additional tax and $500 in California additional tax, on top of regular income tax in both systems.

A solo 401(k) that permits loans gives you another option in a cash crunch. The IRS says loans aren’t permitted from IRAs or IRA-based plans such as SEPs, and are possible only from qualified plans like a 401(k).

What if I retire out of state?

California generally stops taxing the account once you’re a nonresident. Publication 1005 says California doesn’t tax retirement income received by a nonresident after December 31, 1995, and lists SEPs and self-employed plans among the covered income. That’s a question to plan around with your CPA before you move, especially for a large balance.

What changes if I hire an employee?

Both plans stop being “solo.” A SEP has to cover every eligible employee at the same contribution rate you give yourself. The IRS says employees must be included if they’re at least 21, have worked for you in at least 3 of the last 5 years, and earned the minimum compensation, which is $800 for 2026. A generous SEP for you becomes the same percentage for them.

A one-participant 401(k) loses its exemption from nondiscrimination testing when you hire. The IRS says eligible employees must be included and their deferrals are tested, unless the plan is a safe harbor design. Plans marketed as “solo” still have to follow the Internal Revenue Code. Before you hire, read my page on employee vs. independent contractor in California, because the classification decides whether the person counts.

Hiring also brings in CalSavers, California’s state-run retirement program. The definition of “eligible employer” in Gov. Code § 100000(d)(1) excludes sole proprietors, self-employed individuals, and businesses that employ no one other than the owners. Once you have an eligible employee, you’re in the program’s scope unless you offer your own qualifying plan.

How does the plan fit into my estate plan?

Through the beneficiary designation, which controls the account no matter what your will or trust says. The plan you choose changes the spousal rules that apply to that form.

A solo 401(k) is a qualified plan. Under 26 U.S.C. § 401(a)(11)(B)(iii), a profit-sharing plan like a 401(k) can avoid annuity requirements only if the account is payable in full to your surviving spouse at death, unless the spouse consents in the manner § 417 requires to a different beneficiary. If you’re married and want the account to go to your trust or your children, your spouse’s written consent is part of the paperwork. My page on 401(k) spousal rights goes through it.

A SEP IRA is an IRA, so that federal consent rule doesn’t apply the same way. California’s community property rules still can. Under Fam. Code § 760, property a married person acquires during marriage while living in California is community property unless a statute says otherwise, and that generally includes retirement savings built from earnings during the marriage. Either way, the account passes to named beneficiaries outside probate, and most non-spouse beneficiaries face the 10-year rule for inherited retirement accounts.

If your business is the rest of your estate, the retirement account and the company should be planned together. See business succession planning in California for the company side, and retirement beneficiary guides for naming a trust as beneficiary.

Which plan should I choose?

That’s your call with your CPA, and the facts that usually decide it are simple to list.

• You want the largest contribution at a moderate income: the solo 401(k) usually allows more.
• You’re setting up after year-end and want to deduct for last year: the SEP is simplest, and a solo 401(k) can still work for the employer piece.
• You expect to hire within a year or two: think about who the plan will have to cover before you set the rate.
• You want minimal paperwork: the SEP has no annual IRS filing, while a solo 401(k) needs Form 5500-EZ once assets pass $250,000.
• You want Roth money or a loan feature: check what the plan document permits, since both plans can allow Roth and only the 401(k) can allow loans.

Questions to bring your CPA: your exact net earnings after the self-employment tax deduction, whether Roth or pre-tax deferrals fit your bracket, how the choice interacts with the S corporation salary, and whether your entity choice still makes sense. My pages on LLC vs. S corp and single-member LLC or S corp election cover that last one.

Frequently asked questions

Can I have both a SEP IRA and a solo 401(k)?

It’s restricted. The IRS says that if you set up your SEP with Form 5305-SEP, the IRS model form, you can’t have any other retirement plan except another SEP. Other SEP documents may allow it, but the contribution limits are combined, so a second plan rarely adds room. Ask your CPA before opening both.

Can my spouse contribute to my solo 401(k)?

Yes, if your spouse works in the business and earns compensation from it. The IRS describes the one-participant 401(k) as covering an owner with no employees, or the owner and a spouse. Each spouse has a separate deferral limit, which can double the household’s contribution room.

Is a solo 401(k) worth it if I don’t earn much?

Often more so. The employee deferral can be up to 100 percent of compensation, up to the annual limit, so at $40,000 of profit a solo 401(k) can take about four times what a SEP can. The trade-off is a written plan document and, eventually, the Form 5500-EZ.

What’s the deadline to open a SEP for 2026?

The due date of your 2026 business income tax return, including extensions. Contributions for 2026 are due by the same date.

Does California tax my contributions?

No, not if they’re deductible or excluded federally. The FTB’s Publication 1005 says California’s SEP deduction matches the federal deduction, and its 401(k) deferral limits match the IRS’s. Roth contributions are made with after-tax dollars in both systems.

Can I roll my SEP into a solo 401(k) later?

Often, if the 401(k) plan document accepts rollovers. The IRS says SEP contributions and earnings may be rolled over tax-free to other IRAs and retirement plans. Check the plan document before you move money.

Do I need a lawyer to set up either plan?

Usually not. Providers offer IRS pre-approved documents for both. Where I help is the beneficiary designation, the spousal consent, and making sure the account and the business are coordinated with your trust.