After Layoff: SEP-IRA vs Solo 401(k) on $90K Consulting

The decision, resolved with numbers

Meet Daniel. He was laid off from a Charlotte fintech in February 2026 and, by March, had lined up consulting work for two former clients. He expects roughly $90,000 of net self-employment income for the year (after the modest expenses of a home-based one-person shop). He files single, lives in North Carolina, and wants to shelter as much of that income as possible while he’s between full-time roles.

His two realistic options are the SEP-IRA and the Solo 401(k). Both are easy to open at any major custodian. The SEP looks simpler. But on Daniel’s exact numbers, the Solo 401(k) lets him contribute about $41,228 versus roughly $16,728 in a SEP — an extra $24,500 of tax-sheltered savings, and about $5,390 more in first-year federal tax savings. Same income, same custodian, same effort. The only difference is which box he checks.

The reason is structural, and it’s the single most important thing to understand about these two accounts.

Why the Solo 401(k) wins: two contributions vs one

A SEP-IRA has exactly one lever: an employer contribution capped at 25% of compensation (IRC §408(k)), which for a self-employed person works out to about 20% of net earnings after the half-self-employment-tax adjustment. On $90K of net income, that’s it — around $16,728.

A Solo 401(k) has two levers, because the tax code lets you wear both hats:

1. Employee salary deferral — up to $24,500 for 2026 under IRC §402(g), the same limit as a corporate 401(k). This is a flat dollar amount you can defer regardless of the 20% profit-sharing math.
2. Employer profit-sharing — the same ~20%-of-net-earnings contribution the SEP allows, about $16,728 on Daniel’s income.

Stack them: $24,500 + $16,728 = $41,228. The employee deferral is pure addition — it doesn’t reduce the profit-sharing piece. That’s why at moderate income the Solo 401(k) buries the SEP. The lower your income, the bigger the gap in percentage terms, because the fixed $24,500 deferral is a larger share of a smaller pie.

The math, line by line (single filer, $90K net)

Here’s exactly how Daniel’s numbers fall out. The starting point for both accounts is the same: net profit reduced for the self-employment-tax deduction.

From that $83,642 of plan compensation, here’s how the two accounts diverge:

After the half-SE-tax deduction ($6,358) and the 2026 single standard deduction ($15,750), Daniel’s taxable income before any retirement contribution is about $67,892 — squarely in the 22% bracket (single, $48,476–$103,350 for 2026 per IRS Rev. Proc. 2025-32). So every deductible dollar he shelters is worth 22 cents federally. The Solo 401(k)’s extra $24,500 of deferral saves him an additional $5,390 compared with the SEP. North Carolina’s flat income tax adds a bit more on top, since the state starts from federal adjusted gross income.

The trap most people miss: the SEP kills your backdoor Roth

Here’s the part that almost nobody models when they pick the “simple” SEP. A SEP-IRA is, for tax purposes, a pre-tax IRA balance. That matters because of the pro-rata rule in IRC §408(d)(2): when you do a backdoor Roth (contribute $7,500 nondeductible to a traditional IRA, then convert it), the IRS aggregates all your IRAs — traditional, SEP, and SIMPLE — and treats the conversion as coming proportionally from pre-tax and after-tax money.

Daniel earns $90K, so for 2026 he’s under the Roth IRA income phase-out (single $150K–$165K) and could just contribute directly this year. But income is lumpy for consultants. The year he lands a $200K contract, he’ll be over the limit and will want the backdoor route. If he has a $16,728 SEP balance sitting there:

• Total IRA balance after a $7,500 nondeductible contribution: $24,228
• After-tax portion: $7,500 ÷ $24,228 = about 31%
• Taxable portion of the conversion: about 69% — he’d owe income tax on roughly $5,170 of what was supposed to be a clean, tax-free backdoor.

A Solo 401(k) is not an IRA. It does not appear in the §408(d)(2) pro-rata calculation at all. You can run a clean backdoor Roth alongside a Solo 401(k) with $0 of unexpected tax. This is a second, compounding reason the Solo 401(k) wins: it keeps your IRA pro-rata fraction empty for future backdoor conversions.

When the SEP is actually the right call

The SEP isn’t worthless — it’s just usually the wrong tool for a single-person consulting shop at moderate income. The SEP genuinely wins in three narrow cases:

• You’re past the year-end Solo 401(k) deadline. A SEP can be opened and funded up to your tax-filing deadline (including extensions, generally October 15). If it’s already January and you never set up a Solo 401(k) by December 31, the SEP is your only way to shelter prior-year income with an employer contribution.
• Your income is high enough that the deferral doesn’t matter. Above roughly $290K of net earnings, the 20% profit-sharing alone hits the $72,000 §415(c) ceiling, so the SEP and Solo 401(k) shelter the same total. The gap only exists at moderate income.
• You want zero paperwork and won’t ever use a backdoor Roth. The SEP has no Form 5500 filing requirement even at high balances, whereas a Solo 401(k) must file Form 5500-EZ once assets exceed $250,000.

For Daniel — moderate income, lumpy future earnings, wants to maximize the shelter — none of these apply. The Solo 401(k) is the answer.

Deadlines: the rule that catches laid-off workers off guard

The contribution deadlines for these two accounts are different, and getting it wrong forfeits the deferral entirely.

1. Employee deferrals (Solo 401(k) only) require the plan to exist by December 31. You cannot retroactively defer salary into a plan that didn’t exist during the year. SECURE 2.0 §317 lets a sole proprietor adopt a plan by the tax-filing deadline for the first plan year — but that retroactive adoption only covers the employer profit-sharing piece, not the $24,500 employee deferral. To capture the deferral, open the Solo 401(k) by year-end.
2. Employer profit-sharing (both accounts) can be funded up to your extended filing deadline, generally October 15 of the following year.
3. Watch the §402(g) overlap. If you were a W-2 employee earlier in the layoff year and deferred into your old employer’s 401(k), that counts against the same $24,500 deferral limit. Subtract what you already deferred there from what you can put into your new Solo 401(k).

The practical move: if you’ve picked up consulting income mid-year after a layoff, open the Solo 401(k) now, well before December 31, even if you fund it later. The account’s mere existence by year-end is what preserves your $24,500 deferral.

Roth flavor: another edge for the Solo 401(k)

A SEP-IRA is pre-tax only (a Roth SEP technically exists under SECURE 2.0, but few custodians offer it). A Solo 401(k) at most major providers offers a Roth deferral bucket, so Daniel could split his $24,500 deferral between pre-tax and Roth. In a low-income gap year between jobs — when his marginal rate is temporarily 22% instead of the 24% or 32% he saw as a salaried employee — routing some deferral to Roth locks in tax-free growth at a discounted rate. That flexibility simply doesn’t exist in a standard SEP.

Quick comparison table

What about hiring help later?

One real caveat: the “Solo” in Solo 401(k) is literal. If Daniel hires a non-spouse employee who works more than 1,000 hours in a year (or meets the long-term part-time rules under SECURE 2.0), the Solo 401(k) breaks — it’s only for owner-and-spouse businesses. A SEP, by contrast, scales to employees, but then you must contribute the same percentage of compensation for every eligible employee, which gets expensive fast. For a consultant who plans to stay a one-person (or owner-plus-spouse) operation through the gap year, this is a non-issue. If you expect to build a team, revisit plan design before you hire.

The decision lever

Pick the account by answering one question: is your net self-employment income below roughly $290K, and do you have no non-spouse employees? If yes — which describes virtually every freshly-laid-off worker doing solo consulting — open the Solo 401(k) and open it before December 31. The $24,500 employee deferral it adds on top of the same profit-sharing the SEP offers is worth about $5,390 in first-year federal tax alone on $90K of income, and it keeps your backdoor Roth clean for the years your consulting income spikes above the Roth limit. The SEP’s only genuine edge — the later setup deadline — matters only if you missed the year-end window. Don’t miss it.