Retirement Plans for the Self-Employed

A business owner’s retirement account is also one of the largest deductions available, and the choice of plan is covered in full in section “Tax Advantaged Accounts”. The decision in brief:

SEP-IRA

Simple to run, but employer-funded only — contributions are capped at 25% of compensation. Reaching the overall annual limit requires a large income.

Solo 401(k)

Allows both an employee deferral and an employer contribution, so it reaches the same overall limit at a much lower income. It also permits Roth contributions and, unlike a SEP-IRA, leaves no pre-tax IRA balance to trigger the pro-rata rule that undermines the section “Backdoor Roth IRA”.

Cash balance plan

A defined-benefit pension structured as a hypothetical account balance, layered on top of a Solo 401(k). The contribution is computed actuarially against an age-indexed retirement target, so the limit rises sharply with age: a 50-year-old owner can typically defer $150,000–$200,000 per year on top of the Solo 401(k); a 60-year-old can reach $300,000–$400,000. The combined structure is the largest pre-tax deferral available to a self-employed taxpayer, and for a high-bracket sole owner aged 45 and above it is the single most powerful retirement vehicle in the Code. The cost is real — an actuary must sign Form 5500 each year, the plan must be funded on a binding schedule regardless of income variance, and if employees are added the plan must include them on non-discriminatory terms. Treat it as a multi-year commitment, not a one-off tax shield, and pair the actuary with a TPA who has administered dozens of these plans instead of merely studying them. The coordination rule that decides whether the structure actually deducts — the 6% profit-sharing constraint under IRC §404(a)(7), which binds because an owner-only plan is not PBGC-covered — is in section “Defined Benefit and Cash Balance Plans”.

For most owners without employees, the Solo 401(k) is the better instrument until taxable income clears roughly $500,000; above that, layer a cash balance plan on top. See section “Solo 401(k) plans” and section “Individual Retirement Arrangements (IRAs)” for the mechanics and limits. The moment you have employees who are not your spouse, none of the above is the right starting point — the controlled-group and affiliated-service-group rules in section ““No Employees” Is a Legal Conclusion, Not a Headcount” decide what you are even eligible for, and the safe harbor and cross-tested designs in section “Plans for a Business With Employees” are where owners with staff actually end up. section “Choosing Among the Self-Employed and Small-Business Plans” maps the whole decision — employees against profit — onto a single table.