As a small business owner, you wear many hats. One of the most overlooked opportunities is using a retirement plan not just to build your future, but to actively lower your tax bill today. The right plan can turn a significant portion of your pre-tax income into tax-deferred savings—directly reducing your taxable income for the year.
Two of the most powerful options for self-employed individuals and small business owners are the SEP IRA (Simplified Employee Pension) and the Solo 401(k). Both allow generous contributions, are relatively easy to administer, and offer distinct advantages depending on your situation.
Understanding the SEP IRA
A SEP IRA is a traditional IRA that allows business owners to contribute up to 25% of their net earnings from self-employment, with a maximum contribution of $66,000 for 2024 (subject to annual adjustments). It’s straightforward: you open an account, fund it by your tax filing deadline (including extensions), and deduct the contribution on your personal return.
Who benefits most?
- Sole proprietors or single-member LLCs with no employees (except possibly a spouse)
- Businesses with irregular income who need flexible annual contributions—you can skip a year if cash flow is tight
- Owners who want minimal administrative burden—no annual IRS reporting is required for the plan itself
Because contributions are entirely employer-funded, you have full control over if and how much to contribute each year.
The Solo 401(k) Advantage
A Solo 401(k), also known as an individual 401(k), is designed for owner-only businesses with no full-time employees (other than a spouse). It offers two ways to save:
- Employee deferral: Up to $23,000 in 2024 ($30,500 if age 50+) as an elective salary deferral
- Employer profit-sharing: Up to 25% of compensation (net earnings), capping the combined total at $66,000 (or $73,500 with catch-up)
This dual contribution structure often allows higher savings at lower income levels compared to a SEP IRA. For example, a self-employed individual earning $100,000 could potentially contribute around $20,000 as employee deferral plus an additional ~$18,000 as employer profit-sharing—roughly $38,000 in total, significantly more than the 25%-only cap of a SEP IRA.
Added benefits
- Roth option: Many Solo 401(k) plans allow Roth after-tax contributions, giving tax-free growth
- Loan feature: You may borrow against your Solo 401(k) if needed, which SEP IRAs don’t permit
- Rollovers: You can consolidate other retirement accounts into the Solo 401(k) for streamlined management
Choosing the Right Plan
Your choice depends on income predictability, whether you have employees, and how much you want to save annually.
- Go with a SEP IRA if you prefer absolute simplicity, have variable income, or want to make a last-minute contribution before filing taxes.
- Consider a Solo 401(k) if you aim to maximize contributions at moderate income levels, want a Roth option, or may hire employees down the road (you can convert or freeze the plan).
Both plans reduce your taxable income dollar-for-dollar in the contribution year. This direct tax deduction can help you stay in a lower marginal bracket, potentially saving thousands while accelerating your retirement goals.
Practical Steps to Get Started
- Project your net income for the year to estimate the contribution room.
- Choose a provider: Low-cost online brokers or your financial advisor can set up the plan quickly.
- Fund the account well before your tax deadline so the deduction counts for that tax year.
- Track contributions consistently—over-contributions can trigger penalties.
Our team at Andean Consultants helps business owners structure these decisions within a broader financial planning framework to align tax savings with long-term goals.
Common Misconceptions
- “I can’t have a retirement plan because I’m a sole proprietor.” False. Both SEP and Solo 401(k) are built exactly for self-employed individuals.
- “The deduction isn’t worth the hassle.” On the contrary, the immediate tax reduction can fund a large portion of your retirement contribution. For someone in the 32% bracket, a $20,000 contribution could save $6,400 in federal tax.
- “I have to decide by December 31.” For SEP IRAs, you can open and fund until the tax filing deadline. Solo 401(k)s must be established by December 31, but contributions can be made up until the filing deadline.
Integration with Your Business Structure
If you’re considering an S-Corp election, retirement contributions from the business become a deductible expense, further reducing corporate taxable income. Working with a tax professional ensures you draw a reasonable salary and optimize both payroll deductions and retirement contributions without triggering IRS scrutiny.
Next Steps
Retirement planning is not just about the future—it’s a powerful tax tool for today. Whether you're leaning toward a SEP IRA’s simplicity or a Solo 401(k)’s higher limits, the key is to act before tax deadlines and with proper guidance.
Ready to see how these options fit your business? Contact our team for a personalized assessment that balances cash flow, tax savings, and retirement readiness.