SEP IRA vs. 401(k): Which Retirement Plan Fits Your Business?

A SEP IRA is funded only by employer contributions, up to 25% of compensation and capped at $72,000 for 2026, with no employee deferrals and no catch-up contributions. A 401(k) adds a $24,500 deferral on top of employer money, which is why a solo 401(k) usually shelters more for the self-employed at most income levels.

By the About401K editorial team · Facts verified against IRS Notice 2025-67 and IRC §408(k) · Updated September 25, 2026

What is a SEP IRA and how does it work?

A SEP, short for Simplified Employee Pension, is the most stripped-down retirement plan in the tax code. The employer contributes money directly into a traditional IRA owned by each participant, and that is the entire design. There is nothing else to it.

Because the money lands in ordinary IRAs, almost all of the usual plan machinery disappears. There is no plan document to administer beyond a short form, and many employers simply use IRS Form 5305-SEP. There is no annual filing, no nondiscrimination testing, and the money is 100% vested the moment it arrives. No vesting schedule ever applies, which means an employee who quits next week keeps every dollar you put in.

Contributions come only from the employer, up to 25% of each participant’s compensation. They are capped by the same $72,000 total-additions ceiling that governs 401(k)s for 2026 (IRC §415(c) and IRS Notice 2025-67), with compensation counted only up to $360,000.

For a sole proprietor, that “25% of compensation” works out to roughly 20% of net self-employment income after the deduction for half of your self-employment tax. It is the same math as the employer side of a solo 401(k), and the lower percentage catches people off guard every year. One genuinely nice feature is that the amount is discretionary. You can contribute the full 25% in a strong year and nothing at all in a lean one, with no penalty for skipping.

The no-deferral gap

Here is the cleanest way to think about the difference. Everything a SEP can do, the employer-money half of a 401(k) also does. The 401(k) then adds a second contribution channel that the SEP simply does not have.

• No deferrals. A 401(k) participant can put in $24,500 of their own pay for 2026 (IRC §402(g)), regardless of what the employer contributes. A SEP participant can contribute nothing of their own to the SEP. Their separate personal IRA limit of $7,500 for 2026 is unaffected, but it is small by comparison.
• No catch-up, at any age. The 401(k)’s $8,000 age-50 catch-up and $11,250 super catch-up at ages 60–63 are deferral-based, so a SEP has no equivalent. A 55-year-old maxing both structures can put $80,000 into a 401(k) for 2026 but only $72,000 into a SEP.
• No loans. SEP money lives in IRAs, and an IRA can never make a participant loan. If borrowing from your own retirement money is something you want available, the SEP closes that door permanently.

The table below lines up the two structures feature by feature. Read it as a decision aid rather than a scorecard, because the last row is the one that pushes some owners toward the SEP despite everything above it.

SEP IRA vs. solo 401(k) for the self-employed

For an owner with no employees, the solo 401(k) usually wins, and the gap is widest at ordinary incomes rather than at the top. Both plans allow the same employer contribution, roughly 20% of net self-employment income for a sole proprietor. The solo 401(k) then stacks the $24,500 deferral on top of it.

Put real numbers on that and the difference stops being abstract. At $120,000 of net self-employment income, a solo 401(k) shelters roughly $46,800 while a SEP shelters roughly $22,300. The solo plan also permits Roth deferrals, catch-up contributions, and, if the plan document allows, loans.

The SEP’s honest advantages are simplicity and deadline flexibility, and those are worth something. A SEP can be both established and fully funded as late as your tax-filing deadline including extensions, with no deferral-election timing to manage and no Form 5500-EZ even at large balances. If you want employer-only contributions with genuinely zero administration, a SEP is a reasonable choice. If you want the maximum shelter per dollar of income, it is not.

The trap: a SEP must cover your employees at the owner’s percentage

This is the rule that blindsides owners who have staff, and it is the single most important thing on this page if you employ anyone. A SEP must cover every eligible employee, generally meaning anyone 21 or older who worked for you in 3 of the last 5 years and earned above a small indexed compensation minimum.

Here is the part that costs money. Contributions have to be a uniform percentage of compensation for everyone covered (IRC §408(k)). Contribute 20% of your own pay and you must contribute 20% of each eligible employee’s pay as well. Every dollar of it is immediately vested and theirs to keep, even if they leave the following month.

A 401(k) handles employees far more cheaply. Employer money can take the form of a match that only goes to workers who actually defer, it can sit behind a vesting schedule, and safe-harbor formulas in the 3% to 4% range satisfy the rules without mirroring the owner’s percentage. Once you have even one long-tenured employee, the SEP’s simplicity usually stops being worth its uniform-contribution price. Run both sets of numbers before you assume otherwise.

SEP IRA vs. workplace 401(k): different animals

If you are an employee rather than an owner, there is no real comparison to make here. You get whichever plan your employer sponsors, and you do not get a vote. A SEP is a plan that a business owner adopts, usually at a small company, while a 401(k) is what larger employers run.

The one place these two genuinely intersect is the person with a day-job 401(k) and self-employment income on the side. That person can have both plans at once, which is the situation the next section covers.

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

Yes, and it is common. A day-job 401(k) and a SEP for your side business coexist cleanly, because the two limits attach to different things. One follows you as a person and the other follows each employer.

• The $24,500 deferral limit is per person across all plans (IRC §402(g)). SEP contributions are employer money, so they never touch that limit at all. You can max your deferrals at work and still receive a full SEP contribution from your own business.
• The $72,000 total-additions limit is per employer (IRC §415(c)). An unrelated day-job employer and your own business each get their own $72,000. But if the same business sponsors both a SEP and a 401(k), those plans share one limit, and combining a Form 5305-SEP with another plan at the same employer is not permitted. A business that wants both contribution channels should just use a 401(k).

The Roth SEP IRA option

Roth SEP contributions are legal. SECURE 2.0 (§601) authorized them starting in 2023, taxed to you in the year contributed and growing tax-free like other Roth money.

In practice, though, custodian and payroll support has been slow to arrive, and many providers still offer traditional-only SEPs years after the law changed. If Roth treatment matters to you and your provider does not support it, a solo 401(k) with a Roth feature is the more reliable route.

There is also a fallback. Traditional SEP balances can be converted to a Roth IRA later, which is a taxable event in the conversion year but leaves the door open if your provider never catches up.

Related reading

• Solo 401(k): the bigger option for owners with no employees
• The 415(c) limit: how the $72,000 cap works
• All 2026 contribution limits in one table

Sources: IRS SEP plan FAQs · IRC §408(k) · IRS Notice 2025-67 (2026 limits) · IRS: choosing a SEP