Compute your maximum SEP IRA contribution as a self-employed sole proprietor. 20% of net SE earnings, up to $70,000 in 2026.
Maximum SEP IRA contribution
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Federal tax savings
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2026 IRS hard cap
$70,000
Why a sole proprietor's rate is 20, not 25
A SEP IRA is the simplest serious retirement account a self-employed person can open. No annual filing until assets get large, no payroll, just a percentage of your earnings tucked away pre-tax each year. The headline rule is that you can contribute up to 25 percent of compensation, but sole proprietors quickly notice their effective rate is 20 percent, and that confuses almost everyone the first time. The reason is circular math. For someone with a W-2, compensation is a clean salary figure. For a sole proprietor, compensation is net earnings after both half of self-employment tax and the SEP contribution itself are subtracted, and because the contribution depends on the very number it reduces, solving the loop turns 25 percent of post-contribution earnings into 20 percent of pre-contribution net earnings. This tool runs that calculation and caps the result at the 2026 IRS limit of $70,000.
Sheltering $27,881 on $150,000 of profit
Walk through the defaults: $150,000 of net self-employment income at a 32 percent marginal rate. First, self-employment tax is $150,000 times 0.9235 times 0.153, which is $21,194; half of that, $10,597, is deductible and comes off the base. That leaves $139,403 of adjusted net earnings. Multiply by 20 percent and the maximum SEP contribution is $27,881, comfortably under the $70,000 ceiling. At a 32 percent marginal rate, contributing the full amount cuts your federal income tax by about $8,922 while moving that money into a tax-deferred account that compounds untouched until retirement.
| Step | Amount |
|---|---|
| Net self-employment income | $150,000 |
| Less half of SE tax | $10,597 |
| Adjusted net earnings | $139,403 |
| Times 20% | $27,881 |
| Tax saved at 32% | $8,922 |
The half-SE-tax step that lowers your base
That deduction for half of self-employment tax is not a quirk; it is the code treating you fairly. A regular employee splits Social Security and Medicare taxes with an employer, who pays half and deducts it as a business expense. A self-employed person pays both halves, so the law lets you deduct the employer-equivalent half as an adjustment to income. The SEP calculation respects that by computing your contribution base on earnings after that deduction. Skip the step and you would overstate both your contribution room and your deduction, which is a common error in back-of-envelope estimates.
SEP, Solo 401(k), and the same hard cap
Where a SEP stops being optimal is at moderate incomes. Because a SEP gives only the 20 percent employer-style contribution, a sole proprietor often shelters more in a Solo 401(k), which adds a flat employee deferral on top of the same 20 percent. At $150,000 of profit, a Solo 401(k) would beat the SEP's $27,881 by a wide margin once the deferral is added. The SEP catches up only at very high income, where both plans bump against the same $70,000 combined ceiling and the simplicity of the SEP wins. A practical tip: you have until your tax filing deadline, including extensions, to open and fund a SEP for the prior year, which makes it a rare retirement move you can still make after December 31. The deadline and contribution mechanics are spelled out in IRS Publication 560. One caveat: if you have employees, a SEP generally requires you to contribute the same percentage of pay for each eligible worker, which can make it expensive to fund just yourself.
Can I still contribute to a personal IRA if I have a SEP?
Yes. A SEP IRA is funded by the business and is separate from your personal traditional or Roth IRA, so you can contribute to both in the same year up to each one's own limit. Whether your personal traditional IRA contribution is deductible may be limited, however, because being covered by a SEP counts as being an active participant in a workplace plan for the IRA deduction phase-out.
What if my income varies wildly from year to year?
A SEP is well suited to lumpy income because the contribution is discretionary; there is no required annual amount. In a strong year you can fund the full 20 percent, and in a lean year you can contribute little or nothing without penalty. That flexibility is one reason freelancers and seasonal businesses favor it over plans with fixed funding commitments.