Guides / Retirement plans
Choosing a retirement plan for your business.
A retirement plan is the largest deduction most profitable small businesses have available, and the choice between the options is usually decided by three things: whether you have employees besides yourself, how much you actually want to put away, and how late in the year you are asking. That last one eliminates options quietly.
The options
What each plan is for
SEP IRA: simplest, and latest to set up
Employer contributions only, calculated as a percentage of compensation, with no employee deferrals. Its distinguishing feature is timing: a SEP can be established and funded up to the due date of the return including extensions, which makes it the only meaningful option for someone deciding after year end. Its weakness is employees, because every eligible one gets the same contribution percentage as the owner.
SIMPLE IRA: low cost with a small staff
Available to employers with no more than 100 employees. Employees defer from pay and the employer either matches up to a set percentage or makes a smaller contribution for everyone. There is no annual testing and administration is light. The catch is the establishment deadline, generally October 1 for a new plan for the current year, and lower deferral limits than a 401(k).
Solo 401(k): the most efficient owner-only plan
For a business with no employees other than the owner and a spouse. It combines an employee deferral with an employer contribution, which means it reaches a target contribution at a much lower income level than a SEP does. It also permits Roth deferrals and, in many documents, loans. The plan generally has to exist by year end, with a limited exception allowing later adoption in the first year.
Safe harbor 401(k): when you have employees and want to defer fully
A regular 401(k) fails nondiscrimination testing when only the owners participate meaningfully. A safe harbor design sidesteps the testing in exchange for a required matching or nonelective employer contribution that vests immediately. It costs more per employee and it is usually the only way an owner with staff reaches the full deferral limit reliably.
Cash balance and defined benefit: much larger, much less flexible
For an older owner with high, stable income, a cash balance plan can support deductible contributions several times the 401(k) limit, because the contribution is actuarially determined by the benefit promised at retirement. In exchange there is an annual funding obligation, an actuary, and a commitment that is awkward to unwind in a bad year. Often paired with a 401(k) rather than replacing it.
What decides it
Beyond the plan names
Deadlines eliminate options in sequence
By October a new SIMPLE is generally off the table for the current year. By January a solo 401(k) usually is too, subject to a narrow first-year exception. The SEP survives to the extended return due date. Anyone planning seriously should be having this conversation in the third quarter, not in March.
Employees change the arithmetic entirely
Every design that lets an owner contribute heavily also requires something for eligible staff. The question is not which plan lets the owner save most, but which produces the best ratio of owner benefit to total employer cost. Eligibility rules on age, service, and hours are a legitimate part of that design.
The contribution base follows the entity
For a sole proprietor or partner it is net earnings from self-employment after the self-employment tax adjustment and the plan contribution itself. For an S corporation shareholder-employee it is W-2 wages, which means the reasonable compensation decision directly caps the retirement contribution. See reasonable compensation.
Startup credits offset the cost of beginning
Employers under a size threshold that establish a new plan can claim a credit against a large share of startup costs for the first several years, along with a separate credit for employer contributions made for non-highly-compensated employees and an additional credit for adding automatic enrollment. For a small employer these can cover most of the early cost.
Roth options are now much broader
Roth treatment is available in solo and traditional 401(k) plans and, following recent legislation, in SEP and SIMPLE arrangements as well, subject to the plan document supporting it. Whether Roth is preferable depends on the current marginal rate against the expected rate in retirement, which for a Florida resident with no state income tax looks different from the same question in New York.
This page is general information about how the rules work, not tax or legal advice for a specific situation. Facts change outcomes. Talk with the firm before acting on anything here.
Questions
Common questions
It is already March. What can I still do for last year?
A SEP IRA, in most cases. It can be established and funded up to the due date of the return including extensions, which is the reason it remains popular despite being less efficient than a solo 401(k) for the same contribution.
Can I have both a 401(k) and a SEP?
Sometimes, but the interaction is technical and the overall annual additions limit applies across plans of the same employer. More commonly the useful pairing is a 401(k) with a cash balance plan, which is designed to work together.
I have three part-time employees. Do I have to cover them?
It depends on the eligibility conditions in the plan and on the hours worked. Plans may impose age and service requirements, and long-term part-time rules now bring some consistently part-time employees into 401(k) deferrals. It is a design question, and it is worth getting right at adoption rather than by amendment later.
What are the actual dollar limits?
They are indexed and change every year, so we do not publish them here. The current figures are on the IRS retirement plans pages, and we will model your specific numbers when we set the plan up.
Does a retirement plan help with the qualified business income deduction?
Indirectly and sometimes unfavorably. Deductible contributions reduce qualified business income, which reduces the deduction, so the net benefit is smaller than the headline deduction suggests. It is still usually worth doing, but it belongs in the same model as the compensation decision rather than being evaluated alone.
The deadline usually decides it.
Tell us the entity, the payroll, the owner ages, and the target contribution. We will identify which plans are still available this year and what each one costs in employer contributions.