The Choice Most NJ Self-Employed People Get Wrong
When a self-employed person or S-corp owner asks what retirement plan to set up, the most common answer they get is: "Just open a SEP-IRA — it's simple."
That advice is often wrong for NJ taxpayers. Not because SEP-IRAs are bad plans, but because New Jersey doesn't allow IRA deductions on the NJ-1040 — which means a SEP-IRA contribution reduces your federal taxable income but does nothing for your NJ state tax bill. A Solo 401(k) employer contribution, on the other hand, is generally deductible for NJ purposes.
For a NJ taxpayer in the 10.75% top bracket, that difference can mean $3,000–$7,500 per year in additional NJ tax savings — simply by choosing Solo 401(k) over SEP-IRA at the same contribution level.
This guide covers all four main retirement plan options for self-employed NJ taxpayers, the 2026 limits, and the NJ state tax difference that most CPAs don't discuss.
Your Options at a Glance (2026 Contribution Limits)
| Feature | SEP-IRA | Solo 401(k) | SIMPLE IRA | Defined Benefit (Cash Balance) |
|---|---|---|---|---|
| 2026 employee limit | N/A | $23,500 | $16,500 | N/A |
| 2026 employer/total limit | $70,000 | $70,000 | 3% match | Up to $285,000+ |
| Catch-up (50+) | N/A | $7,500 | $3,500 | Actuarially determined |
| Enhanced catch-up (60–63) | N/A | $11,250 | $5,250 | N/A |
| Roth option | No | Yes | Yes (SECURE 2.0) | No |
| Loan provision | No | Yes (up to $50K) | No | Varies |
| Employees allowed | Yes | No (owner + spouse only) | Yes (must offer all) | Varies |
| Admin complexity | Very low | Low–medium | Low | High (actuary required) |
| Establishment deadline | Tax filing deadline | December 31 | October 1 | December 31 |
| NJ deductibility | No | Yes (employer portion) | Varies | Typically Yes |
SEP-IRA: Simplest to Set Up
A SEP-IRA (Simplified Employee Pension) is the simplest retirement plan for self-employed individuals. There are no annual filings, no contribution formulas to track, and minimal administrative burden.
How contributions work: You contribute as the employer. The maximum is 25% of your net self-employment income (after the SE tax deduction), up to $70,000 for 2026. For a W-2 employee of your own S-corp, the limit is 25% of your W-2 wages, up to $70,000.
The catch: SEP-IRA contributions are made on the employer side only — there's no employee deferral component. If you have employees, you must contribute the same percentage for all eligible employees. This is why many sole proprietors outgrow the SEP-IRA once they hire.
Federal tax benefit: The SEP-IRA contribution is deductible on Schedule 1 (Form 1040), reducing your federal AGI.
NJ tax benefit: None. New Jersey does not allow deductions for SEP-IRA contributions on the NJ-1040. Your NJ taxable income is unchanged by the SEP-IRA contribution. As a result, you will have a higher NJ basis in the account — withdrawals in retirement that represent after-NJ-tax contributions are partially excluded from NJ income.
Solo 401(k): Most Flexible for Owner-Only Businesses
The Solo 401(k) (also called individual 401(k) or self-employed 401(k)) is designed specifically for self-employed individuals and owners of businesses with no full-time employees other than the owner and spouse.
Two-part contribution structure:
- Employee deferral: Up to $23,500 for 2026 ($31,000 if age 50+, $34,750 if age 60–63 under SECURE 2.0 enhanced catch-up). This reduces your W-2 wages on Box 1 if you are an S-corp employee.
- Employer profit-sharing: Up to 25% of your W-2 compensation (S-corp) or net SE income (sole prop), subject to the combined $70,000 annual limit.
Roth option: SECURE 2.0 Act expanded Roth availability for Solo 401(k)s. If your plan document allows it, you can make Roth employee deferrals — contributions from after-tax income that grow and are withdrawn tax-free.
Loan provision: Solo 401(k)s can allow loans of up to $50,000 or 50% of the vested balance, whichever is less. No SEP-IRA equivalent.
NJ deductibility — the critical difference: Solo 401(k) employer contributions (the profit-sharing portion) are deductible for NJ purposes. The NJ Division of Taxation's position is that qualified employer contributions to a 401(k) plan reduce NJ taxable income. Employee deferrals have a more complex NJ treatment — they reduce federal W-2 Box 1 wages but NJ may require adding them back, depending on your entity structure.
Establishment deadline: The plan must be established (plan documents signed) by December 31 of the tax year. You can still make contributions up to the tax filing deadline (including extensions), but the plan must exist before year-end.
SIMPLE IRA: When You Have Employees
The SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for small businesses with up to 100 employees who want to offer employees a retirement benefit without the complexity of a full 401(k) plan.
Employee deferrals: Up to $16,500 for 2026 ($20,000 if age 50+, $21,750 if age 60–63).
Employer obligation: You must either match employee deferrals up to 3% of compensation, OR make a flat 2% non-elective contribution for all eligible employees (even non-participants). The 2% option applies to all employees — you can't opt out.
Roth option: SECURE 2.0 added a Roth option for SIMPLE IRAs, effective 2023.
Key limitation: If you withdraw from a SIMPLE IRA within 2 years of the first contribution, the early withdrawal penalty is 25% (not the usual 10%). This "2-year lock" makes SIMPLEs less flexible than 401(k)s for participants who may need early access.
NJ deductibility: Employee deferrals to a SIMPLE IRA reduce federal W-2 Box 1 wages. As with 401(k)s, NJ may require adding back some of these deferrals — the NJ treatment of SIMPLE IRA deferrals is less clear-cut than for 401(k) employer contributions.
Defined Benefit Plans for High-Income Practitioners
A cash balance plan or traditional defined benefit plan allows contributions far beyond the $70,000 defined contribution limit — often $100,000–$285,000+ per year for owners in their late 40s or 50s. This makes them ideal for physicians, attorneys, CPAs, and other high-income practitioners who want to aggressively build retirement savings and reduce taxable income.
The defined benefit promise specifies a projected benefit at retirement. An actuary certifies the annual funding requirement. Contributions to fund the promised benefit are deductible.
NJ deductibility: Employer contributions to a qualified defined benefit plan are generally deductible for NJ purposes.
The catch: Annual actuarial cost (~$1,500–$3,000/year) and minimum funding requirements. Once established, you are obligated to fund the plan at actuarially required levels.
The NJ Factor: Why Your State Return Matters
This is the most important section for NJ taxpayers, and the one most CPAs don't discuss.
New Jersey conforms to federal rules on what contributions can be made, but not to federal rules on deductibility. Specifically:
- NJ-1040 does not allow deductions for IRA contributions (neither traditional IRA nor SEP-IRA) under N.J.S.A. 54A:6-26. This is explicitly stated in the NJ-1040 instructions at line 27a.
- NJ-1040 does allow deductions for employer contributions to qualified pension, profit-sharing, and 401(k) plans under N.J.S.A. 54A:6-25.
What this means in practice:
| Plan Type | Federal Tax Benefit | NJ Tax Benefit |
|---|---|---|
| SEP-IRA | Deductible (reduces AGI) | Not deductible on NJ-1040 |
| Traditional IRA | Deductible (income limits apply) | Not deductible on NJ-1040 |
| Solo 401(k) employer contribution | Deductible (reduces business income) | Deductible on NJ return |
| Solo 401(k) employee deferral | Reduces W-2 Box 1 | NJ treatment complex — may require addback |
| SIMPLE IRA employer match | Deductible | NJ treatment varies |
| Defined benefit plan employer contribution | Deductible | Deductible on NJ return |
The consequence of NJ's non-conformity: if you fund a SEP-IRA with $70,000, your federal AGI drops by $70,000 but your NJ income is unchanged. If you instead fund a Solo 401(k) employer contribution of $70,000, your federal AGI drops by $70,000 AND your NJ income drops by $70,000.
At NJ's top rate of 10.75%, that's $7,525 in additional NJ tax savings per year from the Solo 401(k) — at the same contribution level as the SEP-IRA.
What This Looks Like in Real Numbers
Scenario: NJ S-corp owner, $200,000 W-2 from S-corp, NJ taxable income of $200,000 before retirement contribution. Top NJ bracket (10.75% on income over $1 million — but NJ brackets hit 10.75% at $1M; at $200K, the applicable rate is approximately 8.97%).
| SEP-IRA ($50,000) | Solo 401(k) Employer ($50,000) | |
|---|---|---|
| Federal AGI reduction | $50,000 | $50,000 |
| Federal tax saved (at 24% bracket) | $12,000 | $12,000 |
| NJ income reduction | $0 | $50,000 |
| NJ tax saved (at ~8.97%) | $0 | $4,485 |
| Total tax saved | $12,000 | $16,485 |
The Solo 401(k) employer contribution generates $4,485 more in annual tax savings than the SEP-IRA — with the exact same $50,000 contribution.
Your Retirement Plan Decision Checklist
- [ ] Do you have any full-time employees other than yourself and your spouse? (If yes, Solo 401(k) is not available)
- [ ] What is your net self-employment or W-2 income from your business?
- [ ] Have you established a plan before — if not, do you need to establish it by December 31?
- [ ] Do you want a Roth option for tax-free growth?
- [ ] Do you want a loan provision for emergency access?
- [ ] What is your NJ tax rate on the last dollar of income?
- [ ] Have you modeled the federal vs. NJ tax savings for each plan type?
Frequently Asked Questions
Can I contribute to both a Solo 401(k) and a SEP-IRA in the same year?
Generally no — you can only participate in one plan for the same business. However, if you have multiple unrelated businesses (e.g., an S-corp and a separate sole proprietorship), each business can have its own plan. The combined contribution limits still apply across all plans.
What's the deadline to establish a Solo 401(k)?
The Solo 401(k) must be established (plan documents signed and in place) by December 31 of the tax year. Unlike the SEP-IRA, you can't set up a Solo 401(k) in 2027 and make 2026 contributions — the plan must exist before year-end. However, you can make contributions to an existing plan up to the tax filing deadline (including extensions).
Why does NJ not allow IRA deductions?
New Jersey's income tax was designed with its own set of deductions that don't mirror federal law. Under N.J.S.A. 54A:6-26, NJ specifically excludes IRA deductions. The silver lining: because you don't get a NJ deduction when you contribute, your after-NJ-tax basis in the IRA is higher. When you withdraw in retirement, the basis is excluded from NJ income tax under the NJ IRA exclusion rules.
I have a SEP-IRA already set up. Should I switch to a Solo 401(k)?
Possibly. You can open a Solo 401(k) for the current tax year and stop making SEP-IRA contributions (or terminate it if you prefer simplicity). Existing SEP-IRA funds can remain in the SEP-IRA or roll over to the Solo 401(k) if the plan allows it. The analysis of whether to switch depends on your current contribution level, NJ tax rate, and administrative preferences. I'd recommend running the numbers with a CPA before switching.
Sources and References
- IRC §402 (Solo 401(k) deductibility)
- IRC §408 (IRA rules)
- IRC §219 (IRA deduction — federal)
- N.J.S.A. 54A:6-25 (NJ deduction for qualified plan contributions)
- N.J.S.A. 54A:6-26 (NJ non-conformity with IRA deductions)
- NJ-1040 Instructions, Line 27a (IRA deduction — NJ)
- IRS Publication 560 (Retirement Plans for Small Business)
- SECURE 2.0 Act of 2022 (Pub. L. 117-328)
For a personalized analysis of retirement plan options for your NJ business, contact Monaco CPA at [/services/retirement-planning](/services/retirement-planning).
