Clear Money Guide
What this guide covers
A quick view of the questions and evidence developed below.
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Updated July 28, 2026. Quick answer: Your effective employer rate is 20%, not 25%, and the base is not what most articles say. It is net profit minus one-half of your self-employment tax, minus the contribution itself. “20% of net profit” is wrong — it leaves out the self-employment-tax reduction and overstates what you can put in.
Where the 20% comes from
Publication 560’s Rate Table for Self-Employed carries a 25% row whose value is 0.200000, with this footnote: the deduction for annual employer contributions “can’t be more than 20% of your net earnings (figured without deducting contributions for yourself).”
The arithmetic is that the contribution is deductible in computing the base it is a percentage of, so the rate has to be solved rather than applied: the reduced rate is the plan rate divided by one plus the plan rate. For 25% that is 0.25 ÷ 1.25 = 0.20.
Both “20%” and “25%” are correct — against different bases — and that is exactly why this gets mangled. 20% applies to net profit minus half your self-employment tax. 25% applies to that figure minus the contribution as well. “20% of net profit” is neither, and it is the version you will most often see. On a mid-six-figure net profit the self-employment-tax step alone moves the base by several thousand dollars, so the error is not academic.
| You are | The employer contribution is a percentage of | Effective rate |
|---|---|---|
| Sole proprietor / single-member LLC | Net profit, minus one-half of self-employment tax, minus the contribution itself | 20% |
| Partner in a partnership | The same net-earnings computation, on your distributive share | 20% |
| S corporation owner-employee | Your W-2 wages only. K-1 income and distributions add nothing | 25% |
Get the self-employed plan structure checked
The right plan for an owner depends on the entity, the payroll and whether anyone else is on the books, and an adviser can check the structure before a contribution is made that has to be unwound.
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So does the solo 401(k) still win?
At most incomes, yes — for the same reason as any other entity. The employee deferral stacks on top and IRC §404(n) keeps it out of the 25% deduction limit, while a SEP has no deferral available at all after IRC §408(k)(6)(H) closed salary-reduction SEPs to new plans in 1996.
One advantage that is genuinely yours and not the S-corp owner’s. The Roth catch-up requirement in IRC §414(v)(7) is triggered by FICA wages from the employer sponsoring the plan. A sole proprietor does not have FICA wages. That means the rule does not reach you, while it does reach an S-corp owner-employee at the same income.
Every dollar limit in this area is indexed and changes annually. The figures printed in the Code itself — $40,000 for the defined-contribution limit, $160,000 for the defined-benefit limit, $15,000 for elective deferrals — are 2001 and 2005 base amounts that will never be updated in the statute; IRC §415(d) and §402(g)(4) do the adjusting. Get the current year’s figures from the IRS cost-of-living notice for that year rather than from any article, including this one. Nothing on this page states a dollar amount for that reason.
Sources
IRC §404(a)(3)(A) and §404(h)(1)(C) (the 25% deduction limit); §404(n) (elective deferrals excluded from it); §415(c) and §415(d) (annual additions, and indexing); §401(c)(2) and §1402(a) (earned income); IRS Publication 560, Retirement Plans for Small Business, current edition (the Rate Table for Self-Employed and the Deduction Worksheet); IRS Retirement plan FAQs regarding contributions — S corporation.
This states what the cited authority says. It is not tax advice, and retirement-plan design turns on facts about your business and your other entities that no page can see. Every dollar limit referenced here is indexed and changes annually.
Related
The rate is 20%, not 25%. The contribution calculator does the circular maths the way Publication 560 does it — and reproduces the IRS’s own worked example to the dollar — then puts a solo 401(k) and a SEP side by side at your numbers.
If the self-employment is starting in retirement, the plan choice sits alongside three other systems — the encore business map.
If you are here from a pension rather than a payroll, the prior question is eligibility rather than arithmetic: pension and portfolio income cannot fund a retirement account, and self-employment income can.