One of the most effective tax planning tools available to business owners is a retirement account. Contributions to certain retirement plans reduce taxable income dollar-for-dollar — meaning a $20,000 contribution to a SEP-IRA reduces your taxable income by $20,000 in the year the contribution is made.

The three plans most commonly used by self-employed individuals and small business owners are the SEP-IRA, the Solo 401(k), and the SIMPLE IRA. Each has different contribution limits, setup requirements, and rules about who can participate.

SEP-IRA: Simple and Flexible

The Simplified Employee Pension (SEP-IRA) is the most commonly used retirement plan for self-employed individuals and sole proprietors. It is easy to set up, has no annual filing requirements, and allows contributions up to the tax filing deadline (including extensions).

Contribution limits for 2025: up to 25% of net self-employment income, with a maximum of $70,000. For a sole proprietor, "net self-employment income" is net profit minus the deductible portion of self-employment tax.

If you have employees, a SEP-IRA requires you to contribute the same percentage of compensation for all eligible employees as you contribute for yourself. This makes the SEP-IRA less attractive for businesses with multiple employees, since the employer bears the full cost of contributions.

Solo 401(k): Higher Limits for Owner-Only Businesses

The Solo 401(k) (also called an Individual 401(k) or One-Participant 401(k)) is available to self-employed individuals and business owners with no employees other than a spouse. It allows contributions in two components:

• Employee elective deferral: Up to $23,500 for 2025 ($31,000 if age 50 or older). This is the same limit as a regular 401(k).
• Employer profit-sharing contribution: Up to 25% of net self-employment income (or W-2 wages if operating as an S-corp), subject to the overall limit.

The combined limit for 2025 is $70,000 ($77,500 if age 50 or older). For business owners with moderate income, the Solo 401(k) often allows larger total contributions than a SEP-IRA because of the employee deferral component.

Important: the Solo 401(k) must be established by December 31 of the tax year (unlike a SEP-IRA, which can be opened up to the filing deadline). Contributions can be made up to the filing deadline.

SIMPLE IRA: For Businesses With Employees

The SIMPLE IRA (Savings Incentive Match Plan for Employees) is designed for businesses with 100 or fewer employees. It allows employee contributions of up to $16,500 for 2025 ($20,000 if age 50 or older), with a required employer match.

The employer must either match employee contributions dollar-for-dollar up to 3% of compensation, or make a flat 2% contribution for all eligible employees regardless of whether they contribute. The SIMPLE IRA must be established by October 1 of the year it will be effective.

The SIMPLE IRA has lower contribution limits than the SEP-IRA or Solo 401(k), but it is simpler to administer than a traditional 401(k) plan and may be appropriate for small businesses that want to offer a retirement benefit to employees.

Timing: When Contributions Must Be Made

• SEP-IRA: Can be established and funded up to the tax filing deadline, including extensions (October 15 for most individuals).
• Solo 401(k): Must be established by December 31. Employee deferrals must generally be made by December 31. Employer contributions can be made up to the filing deadline including extensions.
• SIMPLE IRA: Must be established by October 1. Employee contributions are made through payroll. Employer match is made by the filing deadline.

The SEP-IRA's flexibility — allowing both setup and funding after year-end — makes it a useful option for business owners who are not sure of their final income until they prepare their return.

Retirement Accounts and S-Corporations

For S-corporation owners, retirement contributions work differently. The employer profit-sharing contribution is based on W-2 wages paid by the S-corp, not on the owner's total income. This means the contribution limit is tied to the salary the owner pays themselves — another reason why the salary amount matters for S-corp owners beyond just payroll taxes.

S-corp owners can still use a Solo 401(k) or SEP-IRA, but the calculation of the employer contribution is based on W-2 wages rather than net self-employment income. This is a planning consideration when setting the owner's salary.