The main retirement plans for small business owners are the SEP IRA, the Solo 401(k), the SIMPLE IRA and a traditional 401(k). A SEP IRA is the simplest to run. A Solo 401(k) usually lets a self-employed owner with no employees put away the most at moderate incomes. Once you have staff, the right plan depends on how much you want to contribute for them.
This guide is for self-employed people and owners of small teams who want to save for retirement through the business and aren't sure which plan fits. You'll get a side-by-side comparison, decision rules, a worked contribution calculation, and a look at how hiring employees changes the cost. Contribution limits change every year, so the examples show the mechanics rather than current caps. Check the current IRS figures, and have a CPA or financial advisor review your plan choice.
The main plan options at a glance
| Plan | Who funds it | Best fit | Admin effort | Key catch |
|---|---|---|---|---|
| SEP IRA | Employer only | Solo owners and very small teams who want simplicity | Very low | You must contribute the same percentage of pay for every eligible employee |
| Solo 401(k) | Owner as both employee and employer | Self-employed with no employees other than a spouse | Low to moderate | Not available once you have eligible non-spouse employees; annual filing required once assets pass a set level |
| SIMPLE IRA | Employees defer, employer must match or contribute | Businesses with employees that want a low-cost plan | Low | Lower deferral limits than a 401(k); required employer contribution each year |
| Traditional 401(k) | Employees and employer | Growing teams that want flexibility and a recruiting benefit | Higher | Setup and admin fees; nondiscrimination testing unless you use a safe harbor design |
| Defined benefit or cash balance plan | Employer | High, stable earners who want to contribute far more than other plans allow | High, needs an actuary | Required annual funding, even in a lean year |
All of these can usually be paired with traditional (pre-tax) contributions, and several now offer Roth (after-tax) options too. Contributions to traditional plans reduce income tax, but they don't reduce self-employment tax. If that distinction is unclear, our explainer on self-employment tax covers it.
Which retirement plan fits your situation?
Work through these decision rules in order. Stop at the first one that fits, then confirm with your tax advisor.
- You have no employees (or only a spouse) and want to save as much as possible at a moderate income: start with a Solo 401(k). The employee deferral on top of the employer contribution usually beats a SEP.
- You have no employees and want the least paperwork, or you decide late in the year: a SEP IRA. It can generally be opened and funded up to your tax filing deadline, including extensions.
- You have a few employees and want to offer something affordable: compare a SIMPLE IRA with a SEP. A SIMPLE lets employees save their own money, and your cost is capped by the match formula.
- You're hiring steadily and want retirement benefits to help recruit: a traditional 401(k), often with a safe harbor design that avoids annual testing in exchange for a required employer contribution.
- Your income is high and stable and you're behind on savings: ask about adding a cash balance plan alongside a 401(k).
Some states require employers above a certain size to offer a plan or enroll workers in a state-run program. Ask your accountant whether that applies to you.
Worked example: a solo consultant weighing a SEP against a Solo 401(k)
Suppose a hypothetical marketing consultant, operating as a sole proprietor with no employees, has $100,000 of net profit for the year. For a self-employed person, the SEP percentage isn't applied to the full profit. It's applied after subtracting half of self-employment tax, and the contribution itself is part of the calculation. The steps:
- Net earnings subject to self-employment tax: $100,000 × 92.35% = $92,350.
- Self-employment tax: $92,350 × 15.3% = $14,129.55. (This assumes her earnings are below the annual Social Security wage cap.)
- Half of self-employment tax: $14,129.55 ÷ 2 = $7,064.78.
- Adjusted earnings: $100,000 − $7,064.78 = $92,935.22.
- SEP contribution: the plan allows up to 25% of compensation. For a self-employed person, that works out to 20% of adjusted earnings (25% ÷ 125%). $92,935.22 × 20% = about $18,587.
You can check step 5: 25% of what's left after the contribution is 25% × ($92,935.22 − $18,587.04) = 25% × $74,348.18 = $18,587.05. The numbers match, apart from rounding.
The Solo 401(k) alternative. A Solo 401(k) allows the same employer contribution, about $18,587, plus an employee elective deferral up to that year's limit. If she chooses to defer $15,000 as the employee, her total is $18,587 + $15,000 = $33,587, nearly double the SEP.
The tax effect. If her combined marginal federal and state income tax rate is 29%, a pre-tax SEP contribution of $18,587 lowers her income tax by about $5,390. The Solo 401(k) total of $33,587 lowers it by about $9,740. Neither reduces her self-employment tax.
The trade-off is paperwork. A Solo 401(k) needs a plan document, deferral elections made by the plan's deadlines, and an annual information return once assets exceed a threshold. For many solo owners the extra savings capacity is worth it. For someone who only plans to contribute a modest amount, the SEP's simplicity may win.
How hiring employees changes the math
Now imagine a hypothetical landscaping company, organized as an S corporation, where the owner takes a $90,000 W-2 salary. Two eligible employees earn $45,000 and $38,000. In an S corporation, retirement contributions are based on W-2 wages, not profit distributions.
| SEP at 10% | SIMPLE IRA with 3% match | |
|---|---|---|
| Contribution for owner | $9,000 (employer only) | Owner's own deferral + $2,700 match |
| Cost for employee earning $45,000 | $4,500 | Up to $1,350, only if they defer at least 3% |
| Cost for employee earning $38,000 | $3,800 | Up to $1,140, only if they defer at least 3% |
| Maximum employee cost | $8,300 | $2,490 |
The SEP forces the owner to contribute the same 10% for employees, so saving $9,000 for himself costs $8,300 for his team. The SIMPLE shifts most of the saving onto each person's own deferrals, capping his employee cost at $2,490. The SEP is more generous to staff, which may help retention. The SIMPLE is cheaper and lets the owner defer his own salary. Neither is wrong. It depends on what the owner wants the plan to do.
Common mistakes with small business retirement plans
- Opening a SEP and then hiring without reviewing it. Once an employee becomes eligible, they must receive the same percentage you give yourself. Review your plan before each hire, not at tax time.
- Calculating the self-employed SEP limit on gross profit. Using 25% of net profit overstates what you can contribute. Excess contributions can trigger penalties. Use the adjusted calculation or have your CPA run it.
- Missing Solo 401(k) deadlines. Employee deferral elections generally have an earlier deadline than the employer contribution. Setting up the plan late can limit what you can put in for that year.
- Letting retirement funding drain operating cash. Fund the plan from profit after you know your cash position, not in a way that leaves you short for payroll. Plan contributions alongside quarterly estimated taxes so neither surprises you.
- Setting S corporation salary too low. A very low W-2 salary also shrinks the base for your retirement contributions. Your CPA can help find a salary that's both reasonable and practical.
- Ignoring Roth options. If you expect higher tax rates later, some Roth contributions may make sense. It's a trade-off to discuss, not a default.
Where AI can help
An AI assistant can build a side-by-side spreadsheet comparing plans for your business, using your own profit, salaries and headcount, and it can explain unfamiliar terms from a plan document in plain language. It's also useful for drafting a short explanation of a new plan for employees.
Don't rely on it for contribution limits or eligibility rules. AI tools can repeat outdated figures, and retirement plan rules change often. Confirm every limit with current IRS guidance or your plan provider, and have your CPA check the final contribution amounts.
Frequently asked questions
Can I have a SEP IRA and a Solo 401(k) at the same time?
It's possible in some circumstances, but the combined employer contributions generally share the same overall limit, so it rarely adds much. Most owners choose one. Ask your CPA before opening a second plan for the same business.
Can I contribute to a retirement plan if I also have a 401(k) at a day job?
Often yes, but employee deferral limits are generally shared across all 401(k) plans you participate in. Employer contributions from your own business are calculated separately. A tax professional can confirm how the limits apply to you.
When is the deadline to contribute?
Deadlines vary by plan. SEP contributions are generally due by your business's tax filing deadline, including extensions. Solo 401(k) and SIMPLE plans have separate deadlines for setup and employee deferrals. Put them on your calendar when you open the plan.
How much should I contribute each year?
That depends on your cash reserve, debts and goals. A practical approach is to set your owner's salary and reserve first, then contribute a fixed share of remaining profit each year and adjust as the business grows.
Key takeaways
- SEP IRAs are simple but require equal-percentage contributions for eligible employees.
- Solo 401(k)s usually allow solo owners to save more, thanks to the added employee deferral.
- For self-employed owners, contributions are calculated on adjusted earnings, not gross profit.
- With employees, a SIMPLE IRA or 401(k) can cost far less than a SEP at the same owner contribution.
- Limits change yearly, so confirm current figures with the IRS or your CPA before contributing.
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