Tax year 2026 · United States federal
Retirement contributions as a deduction
A SEP-IRA lets a self-employed person contribute 20% of net earnings, not the 25% every summary quotes — the contribution reduces the base it is a percentage of. irs.gov
Getting that wrong does not produce a smaller refund. It produces an excess contribution, which carries a 6% excise tax for every year it stays in the account.
Why 25% becomes 20%
For an employee, “compensation” is their salary and the employer’s contribution sits on top of it. A sole proprietor has no separate employer: the contribution comes out of the same net earnings it is a percentage of. So the definition is circular, in the same way the rate floor is.
The 25% is not wrong. It answers a different question — it applies to compensation after the contribution, which is not a number anybody has in front of them. The full calculation, line by line, is here.
What each plan actually allows
| Net profit | Net earnings | SEP-IRA | SIMPLE IRA | Solo 401(k) | Solo over SEP |
|---|---|---|---|---|---|
| $30,000 | $27,881 | $5,576 | $17,836 | $27,881 | $22,304 |
| $60,000 | $55,761 | $11,152 | $18,673 | $35,652 | $24,500 |
| $100,000 | $92,935 | $18,587 | $19,788 | $43,087 | $24,500 |
| $150,000 | $139,403 | $27,881 | $21,182 | $52,381 | $24,500 |
| $250,000 | $235,213 | $47,043 | $24,056 | $71,543 | $24,500 |
| $400,000 | $383,205 | $72,000 | $27,800 | $72,000 | — |
Two things in that table are the opposite of the usual advice.
The solo 401(k) advantage is largest at LOW income, not high. At $30,000 of profit a SEP allows about a fifth of net earnings and a solo 401(k) allows nearly all of it — because the employee deferral is a flat amount rather than a percentage of anything. irs.gov At the top of the table the advantage is zero, because both plans hit the same ceiling.
The two ceilings bind together, not one after the other. The compensation limit is $360,000 and the overall contribution limit is $72,000. irs.gov Twenty percent of the first is exactly the second — the code sets them at 5:1 deliberately, so for a sole proprietor there is no income at which one has bitten and the other has not.
The deduction is worth less than you think, and less the more you contribute
This is the part that changes decisions, and it is invisible without computing it.
A retirement contribution is an adjustment on Schedule 1, not a Schedule C expense. irs.gov Like health insurance premiums, it never touches self-employment tax. But it has a second effect health premiums rarely reach: contribute enough and you walk yourself down through the tax brackets, so each additional dollar saves less than the one before it.
| Band of contribution | Tax it saves | Return on that band | Saved so far |
|---|---|---|---|
| $0 – $5,000 | $880.00 | 17.6% | $880.00 |
| $5,000 – $10,000 | $880.00 | 17.6% | $1,760.00 |
| $10,000 – $15,000 | $786.82 | 15.7% | $2,546.82 |
| $15,000 – $20,000 | $480.00 | 9.6% | $3,026.82 |
| $20,000 – $25,000 | $480.00 | 9.6% | $3,506.82 |
| $25,000 – $30,000 | $480.00 | 9.6% | $3,986.82 |
| $30,000 – $35,000 | $480.00 | 9.6% | $4,466.82 |
| $35,000 – $40,000 | $480.00 | 9.6% | $4,946.82 |
The first band returns 17.6% and everything above roughly $17,000 returns 9.6%. The last dollar is worth 55% of the first.
Maxing the solo 401(k) at this income means contributing $43,087 to save $5,243 — an average of 12.2%, against the 22% bracket the contributor is nominally in.
What that means, and what it does not
It does not mean contributing less. The tax saving is not the reason to fund a retirement account; compounding is, and a dollar inside the account is still a dollar.
It does mean the tax argument for the last tranche is weak, and that matters when the money has a competing use.
The same arithmetic strengthens the case for a Roth. Giving up a deduction worth 9.6% in exchange for tax-free growth is a far cheaper trade than the headline bracket makes it sound — and the bracket is what most of this decision gets argued from.
Your own numbers
Each quarterly payment
$3,486
- Q1$3,486.35
- Q2$3,486.35
- Q3$3,486.35
- Q4$3,486.36
- Net profit
- $75,000
- Self-employment tax
- $10,597
- Federal income tax
- $4,898
- QBI deduction
- −$10,720
- Total for the year
- $15,495
- Effective rate on profit
- 20.7%
- What you keep
- $59,505
About $1,291 a month set aside, if that is easier to hold to than four lump sums.
State tax not included. State income tax for is not included in this figure. The federal number above is complete; your total liability will be higher by whatever charges. See which states are covered at /state-taxes/, or check your state's revenue department for its current rate. What this site covers, state by state.
Three details worth more than most of the advice
The deferral limit is per person, not per plan. irs.gov Somebody with a day job who defers $15,000 there has $9,500 of solo 401(k) deferral room left, not $24,500. The employer side is unaffected — that one is per plan.
The catch-up sits outside the overall limit. From 50 it is $8,000; from 60 to 63 it is $11,250, and that figure replaces the $8,000 rather than stacking with it. irs.gov At 64 it drops back down, which surprises people.
Deadlines differ by plan and that is the thing to check first. A SEP can be opened and funded up to the filing deadline including extensions. A solo 401(k) generally has to exist before the year ends to accept an employee deferral for it. Discovering that in March is discovering it too late — with one first-year exception that most summaries of the rule leave out.
Where to stop and ask
Which plan to open is a separate decision, and it turns on contribution room rather than on the deduction — with one exception that outweighs the room.
If you have employees, everything above changes — a SEP requires the same contribution rate for eligible staff as for you, which is the point at which a plan built for one person stops being cheap. And if you are weighing this against an S-corp election, the two interact: the election changes what counts as compensation, and therefore the base for all of it.