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Two owners each make $90,000 of profit this year. One can put roughly $16,700 into a retirement account. The other can put in roughly $40,200. Same business, same income, different plan.
I already laid out the options in the 2024 map of retirement accounts. This piece is the sequel: the math, the 2025 changes, and the contribution room you actually get at different profit levels.
Educational content, not financial, tax, legal or investment advice. Talk to a licensed professional about your situation.
What changed for 2025?
Three things, all from the IRS cost-of-living update published November 1, 2024.2
- The employee deferral limit for 401(k) plans rose from $23,000 to $23,500.
- The overall limit on contributions to a defined contribution plan rose from $69,000 to $70,000.1
- A new, higher catch-up applies to ages 60 to 63: $11,250 instead of $7,500, under SECURE 2.0.2
The IRA limit stayed at $7,000.2 The compensation you can count for plan purposes rose to $350,000.1
How is the room calculated for a sole proprietor?
You are not allowed to use your raw profit. The IRS explains that for a self-employed person, compensation is net self-employment earnings after deducting one-half of self-employment tax and the contributions for yourself.3 The effect is that the employer share works out to about 20% of that adjusted figure, not 25% of profit.5
The self-employment tax itself is 12.4% for Social Security and 2.9% for Medicare, on 92.35% of net earnings, with half deductible.6
The SEP limit is the lesser of 25% of compensation or $70,000.5 The Solo 401(k) gives you that same employer share, plus the employee deferral of up to $23,500, with the total capped at $70,000 before catch-up.13
What does that look like at three profit levels?
Here are rounded, illustrative numbers for a sole proprietor under 50, with no other income, no other plan and no state differences. I did the arithmetic with the formula above. Your numbers will differ.
Read the pattern, not the dollars. The gap is the same $23,500 at every level, because the deferral is a fixed amount, not a percentage. At $50,000 of profit it more than triples the room. At $150,000 it adds about 84%.
Whether you can afford to fill that room is a separate question. Contributing $32,800 out of $50,000 of profit is arithmetic, not advice. The cash runway math comes before the plan.
How does an S corporation change it?
Everything shifts to W-2 pay. In a one-participant plan the employer contribution is up to 25% of compensation, and deferrals can be up to 100% of compensation, within the annual limit.3 So your salary is the base.
| Sole proprietor, $120,000 profit | S corporation, $120,000 profit, $70,000 salary |
|---|---|
| Plan compensation about $111,500 after the SE tax deduction | Plan compensation is the $70,000 W-2 salary |
| SEP room about $22,300 | SEP room about $17,500 |
| Solo 401(k) room about $45,800 | Solo 401(k) room about $41,000 |
| Self-employment tax on all profit | Payroll tax on the salary only |
The S corporation numbers are my invented example, and the $70,000 salary is not a recommendation. I included it to show the tradeoff: a lower salary can save payroll tax and cost you some plan room. I cover how the structure itself works in salary vs distributions.
When can you set the plan up?
A SEP is forgiving. You can establish one for a year as late as the due date of your business income tax return for that year, including extensions, and contributions are due by the same date.4
A Solo 401(k) used to be stricter, because deferrals are normally elected before the compensation is earned. Publication 560 now says a sole proprietor with no employees can adopt a 401(k) after the tax year ends, for 2023 and later years, if it is adopted by the tax filing deadline, without extensions.5 Ask your advisor whether you qualify, because the exception is narrow.
What else decides between them?
Hiring
A one-participant 401(k) covers an owner with no employees, or that owner and a spouse.3 A SEP stays available when you hire, but you must contribute equally for all eligible employees, who generally qualify at 21 with service in three of the last five years and at least $750 of compensation for 2025.14
Paperwork
A one-participant plan generally has to file Form 5500-EZ once it holds $250,000 or more at year end.3 A SEP is lighter.
Features
Some Solo 401(k) plan documents allow loans, hardship withdrawals or a Roth deferral option. Those depend on the document you adopt, so read it.
Brian Preston and Bo Hanson of The Money Guy Show covered a related wrinkle in a video from February 22, 2024. If you already max a workplace 401(k) at a day job, a solo plan can only add the profit-sharing piece. They still called that worthwhile:
it's a huge way to shield ordinary income taxes even if you can't do more salary deferral
Their dollar limits are the 2024 ones, so use the 2025 figures above. The structure of the answer has not changed.
VideoThe Money Guy Show
How To Maximize Your Solo 401(k) Contributions
Six minutes on the day-job overlap, the 457 exception and the filing trigger once the plan passes $250,000.
The best plan is the one you set up and fund. Everything else is homework you use to avoid starting.
What questions should you bring to your CPA?
Bring numbers, not adjectives. These three questions get you further than "which plan is best."
- What is my plan compensation this year? Ask for the figure in dollars, using both a sole proprietor and an S corporation view if you are weighing a change.
- What would each plan allow, and what would each cost to run? Ask for room, setup effort and yearly filings side by side.
- What happens if I hire in the next 12 months? A plan that works for one person can turn into obligations for three.
Then write down the answers. Next year's version of you will not remember why you chose what you chose, and the paper trail also helps when your income changes.
What should you do this month?
- Estimate your profit for the year. Use the last 12 months, not your best one.
- Compute your plan compensation. Net profit after half of self-employment tax, or W-2 wages if you run an S corporation.
- Ask your CPA to run both plans. Same profit, two answers.
- Decide the amount you can fund without touching your reserves.
- Choose the provider last. I will not recommend one. Compare costs and features with a licensed professional.
I dabbled with putting money away between 2015 and 2017, and it helped during a move. Dabbling is not a plan, and my grandmother's question, So what's your retirement plan?, is what made me treat it like one.
The rest of the series is in Investing and Retirement.
Keep building.Ekai
Questions people ask
What are the 2025 limits for a Solo 401(k) and a SEP IRA?
For 2025 the employee deferral limit is $23,500, the catch-up is $7,500 at 50 and older, and $11,250 for ages 60 to 63. The overall limit on contributions to a defined contribution plan is $70,000, and a SEP contribution cannot exceed the lesser of 25% of compensation or $70,000.
Why does a Solo 401(k) usually allow more at moderate profit?
Because it has two parts. The employee deferral is a dollar amount up to $23,500 for 2025, and the employer share is a percentage of compensation. A SEP has only the employer share.
Can I open a plan after the year ends?
A SEP can be set up as late as your tax return due date for that year, including extensions. Publication 560 says a sole proprietor with no employees can adopt a 401(k) after year end if it is adopted by the tax filing deadline, without extensions.
How does an S corporation change the math?
Contributions are based on W-2 compensation, not profit. A smaller salary means a smaller base for the percentage, so the pay decision comes before the plan decision.
Sources
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