Day 9: The mega backdoor strategy (why the SEP IRA is a trap)
Your CPA probably put you in a SEP IRA. Here is why that mistake could cost you $1 million in future taxes.
Most entrepreneurs get bad retirement advice. When you start making real money, your accountant usually tells you to open a SEP IRA. "It is easy," they say. "You can dump money in and take a huge tax deduction today." They are right. It is easy, and you do get a deduction today. But they are missing the bigger picture.
A SEP IRA is a tax deferral tool. You skip taxes now, but you pay them later when you withdraw. You are essentially entering a partnership with the IRS where they own 30% or 40% of your future wealth. If you are an entrepreneur who plans to be wealthy, "tax deferred" is not the goal. "Tax free" is the goal. That is why I move my high income clients out of SEP IRAs and into Solo 401(k)s. It is the Ferrari of retirement accounts; the SEP is a Camry.
The "speed limit" problem
Both plans technically have the same maximum for 2026: $72,000. But the math to get there is completely different.
The SEP IRA (the slow lane): you can only contribute as the employer. For S-Corps the limit is 25% of your W-2 salary. To hit the full $72,000 max you need to pay yourself a massive $288,000 salary, and you pay 15.3% payroll tax on that entire salary. You are burning payroll tax just to get a deduction.
The Solo 401(k) (the fast lane): you wear two hats. As employee you contribute $24,500 right off the top, 100% of your first dollars. As employer you then add 25% of your W-2 on top. You hit the max with a much lower salary, saving thousands in payroll taxes.
Case study: the "lean" IT contractor
I have a client, Marcus, a senior DevOps engineer contracting for big tech. Revenue $300,000, net profit $290,000. He runs an S-Corp and pays himself a $100,000 salary to be reasonable.
- SEP IRA: 25% of $100,000 = $25,000 deduction. He left $47,000 of tax-advantaged space on the table.
- Solo 401(k): $24,500 as employee + $25,000 as employer = $49,500 deduction.
With the exact same salary, Marcus sheltered nearly double the money. At his 35% bracket, that is an extra $8,575 in tax savings this year alone.
The "mega backdoor" (the secret weapon)
This is the feature that makes the Solo 401(k) legendary. Most entrepreneurs focus on tax deferral, but the real game is tax-free growth. If you set up a custom Solo 401(k), you can enable after-tax contributions. Note you cannot do this with generic plans from the big-box providers.
How it works for Marcus: he fills the pre-tax buckets with $49,500. The 2026 limit is $72,000, leaving $22,500 of unused space. He contributes that final $22,500 as voluntary after-tax, then immediately converts it to his Roth 401(k). He just stuffed $22,500 into a Roth in a single year, when the normal Roth IRA limit is only $7,500.
The math: with a SEP IRA, you put in pre-tax, it grows to $1 million, and when you pull it out you pay tax on the full $1 million, so the IRS gets about $350,000. With the mega backdoor Roth, you put in after-tax, it grows to $1 million, and when you pull it out you pay zero. The IRS gets $0. You pay tax on the seed so you don't pay tax on the harvest.
The deadline trap (act now)
- SEP IRA: you can set it up as late as April 15 of next year. The procrastinator's best friend.
- Solo 401(k): you generally must have the plan documents signed by December 31.
- Crucial for S-Corps: since the employee contribution comes from your W-2, you need to run payroll before Dec 31 to defer the money. You cannot defer salary you have not paid yourself yet.
The verdict
Choose the SEP IRA if: it is already January and you missed the Solo 401(k) deadline; you hate paperwork; or you pay yourself such a massive salary ($288k+) that the 25% math gets you to the limit anyway.
Choose the Solo 401(k) if: you want to save the maximum on a salary under $200k; you want the mega backdoor Roth; you want a plan loan (borrow $50k tax-free); or you have a spouse on payroll who can double these benefits.
The action plan
- Check the calendar: Is it before Dec 31? If yes, go Solo.
- Provider check: Don't just open a generic one if you want the mega backdoor.
- Run payroll: If you are an S-Corp, make sure your December payroll includes your employee deferral. The money needs to leave the business account before the ball drops.