Retirement Plans for Business Owners: SEP, SIMPLE, Solo 401(k)

Retirement Plans for Business Owners: SEP, SIMPLE, Solo 401(k)

Retirement plan contributions are one of the most powerful tax deductions available to business owners. You reduce your taxable income today while building wealth for the future. The challenge is choosing the right plan for your situation.

Why Retirement Plans Matter for Taxes

Every dollar you contribute to a qualified retirement plan reduces your taxable income for the year. If you are in the 32% tax bracket and contribute $50,000 to a SEP IRA, you save $16,000 in federal income tax. For self-employed individuals, the contributions also reduce your self-employment tax base.

Contributions grow tax-deferred until retirement. You pay income tax only when you withdraw the funds, ideally when you are in a lower tax bracket.

SEP IRA (Simplified Employee Pension)

A SEP IRA is the simplest retirement plan for self-employed individuals and small business owners.

Key Features

• Contribution limit: Up to 25% of net self-employment earnings (after the SE tax deduction), maximum $66,000 for 2023
• Who contributes: Employer only (you, as the business owner)
• Employee requirement: If you have eligible employees, you must contribute the same percentage for them as you do for yourself
• Setup deadline: Can be established and funded as late as the tax filing deadline (including extensions)
• Administration: Minimal paperwork, no annual IRS filings

Best For

Solo business owners or businesses with few employees who want simplicity and high contribution limits. The SEP is ideal if you want to make a large contribution in a profitable year and skip contributions in a lean year -- contributions are completely discretionary.

Watch Out For

If you have employees, the equal percentage requirement can make a SEP expensive. Contributing 25% of your own income means contributing 25% of every eligible employee's compensation as well.

SIMPLE IRA (Savings Incentive Match Plan for Employees)

The SIMPLE IRA is designed for businesses with 100 or fewer employees.

Key Features

• Employee contribution limit: $15,500 for 2023 ($19,000 if age 50+)
• Employer contribution: Either match employee contributions dollar-for-dollar up to 3% of compensation, or make a 2% non-elective contribution for all eligible employees
• Who contributes: Both employer and employee
• Setup deadline: Must be established by October 1 of the year (for existing businesses)
• Administration: Low paperwork, no annual IRS filings
• Early withdrawal penalty: 25% if withdrawn within first 2 years (vs. 10% for other plans)

Best For

Small businesses that want employees to participate in saving for retirement with modest employer costs. The SIMPLE works well when you want to contribute more than a traditional IRA allows but do not need the high limits of a SEP or Solo 401(k).

Watch Out For

The contribution limit is significantly lower than a SEP or Solo 401(k). You cannot have a SIMPLE IRA and another employer-sponsored plan in the same year.

Solo 401(k)

The Solo 401(k) -- also called an Individual 401(k) -- is available to self-employed individuals with no employees (other than a spouse).

Key Features

• Employee deferral: Up to $22,500 for 2023 ($30,000 if age 50+)
• Employer contribution: Up to 25% of net self-employment earnings (after SE tax deduction)
• Total maximum: $66,000 for 2023 ($73,500 if age 50+)
• Roth option: Many Solo 401(k) plans allow Roth (after-tax) contributions
• Loan provision: You can borrow up to $50,000 or 50% of the account balance (if the plan allows)
• Setup deadline: Must be established by December 31 of the tax year (contributions can be made until tax filing deadline)

Best For

Self-employed individuals and freelancers with no employees who want to maximize contributions. The combination of employee deferrals and employer contributions allows you to shelter more income than a SEP at the same income level.

Watch Out For

Once you hire employees (other than a spouse), you can no longer use a Solo 401(k). You will need to switch to a different plan. Annual IRS filing (Form 5500-EZ) is required once the plan assets exceed $250,000.

Plan Comparison

| Feature | SEP IRA | SIMPLE IRA | Solo 401(k) | |---|---|---|---| | Max contribution (2023) | $66,000 | $15,500 + match | $66,000 | | Catch-up (50+) | None | $3,500 | $7,500 | | Employee deferrals | No | Yes | Yes | | Roth option | No | No | Yes (if offered) | | Loans | No | No | Yes (if offered) | | Employees allowed | Yes | Yes (under 100) | No (except spouse) | | Setup deadline | Tax filing deadline | October 1 | December 31 | | Annual IRS filing | No | No | Over $250k assets |

Choosing the Right Plan

Solo with high income, no employees: Solo 401(k). You get the highest contribution limits and the most flexibility (Roth option, loans).

Solo with moderate income: SEP IRA. Simple to set up and fund, with no annual filings.

Business with employees: SIMPLE IRA if you want low cost and simplicity. SEP IRA if you want higher contribution limits and are willing to contribute the same percentage for employees. Consider a traditional 401(k) if you have more than a few employees and want more sophisticated plan design.

Late in the tax year: SEP IRA is the only option you can set up after year-end (up to the filing deadline including extensions).

Implementation Steps

1. Choose the plan that matches your business structure and goals
2. Open the account with a brokerage or financial institution
3. Adopt the plan document (provided by the custodian)
4. Make contributions by the applicable deadline
5. Report contributions on your tax return
6. If you have employees, provide required notices and disclosures

Consult with a financial advisor or CPA to run the numbers for your specific income level. The difference between plans can mean thousands of dollars in tax savings and retirement accumulation.