Choosing a Retirement Plan for Your Business

How it works

Four vehicles compete for the same job: a SEP-IRA, a Solo 401(k), a SIMPLE IRA, and a defined-benefit or cash-balance plan. The deduction mechanics behind all four are identical: an employer contribution reduces taxable income, above the line on Schedule 1 for a sole proprietor, as an ordinary corporate deduction for an S corporation or C corporation, and the money then grows tax-deferred. What changes from one vehicle to the next is how many dollars a business can legally push into that deduction, at what administrative cost, given who else works there.

Two facts decide the choice: whether the owner has non-owner employees, and how much the owner wants to contribute relative to compensation. With no employees other than a working spouse, a Solo 401(k) is generally the strongest fit: it reaches the same contribution ceiling as a SEP-IRA but gets there at lower compensation, because it adds an employee-deferral component on top of the employer contribution a SEP relies on alone, and it opens the door to Roth contributions and a participant loan, neither of which a SEP offers.

Once employees enter the picture, the question stops being which plan contributes the most and becomes which plan funds the owner without funding everyone else at the same rate. A SIMPLE IRA is inexpensive to run and has no annual filing, but its ceiling is low. A safe-harbor 401(k) paired with a profit-sharing contribution reaches a much higher ceiling for the owner, at the cost of an annual Form 5500 and testing the SIMPLE does not carry.

For a business with high, stable income that wants to contribute past what a defined-contribution plan can hold, the fourth branch is a defined-benefit or cash-balance plan, frequently layered on top of a 401(k) and profit-sharing plan rather than used alone. It targets an annual retirement benefit, funded toward that target actuarially rather than built around a fixed annual contribution, which lets it absorb a far larger deduction in a single year.

What this is worth in Florida

Florida has no individual income tax and does not tax pass-through income at the personal level, so nothing on this page defers a dollar of state tax. Every dollar of benefit from any of these four vehicles is federal: the income-tax deduction and, for a sole proprietor or an S-corp owner drawing wages, the payroll-tax interaction. There is no state-level deferral to layer on top of the federal one, so the plan-selection question in Florida comes down to federal tax effect weighed against administrative cost.

Who this applies to

All four vehicles require self-employment income or W-2 compensation from the sponsoring business. Passive or portfolio income does not count toward any of them, regardless of how large it is.

• SEP-IRA. Available to any business entity, funded entirely by the employer with no employee-deferral component.
• Solo 401(k). Built for an owner-only business, including one where a spouse also works in the business. It stops being a one-participant plan once a non-owner, non-spouse common-law employee works more than 1,000 hours in a year, bringing in full 401(k) coverage and testing rules. Crossing 1,000 hours is not the only way in. Under the long-term part-time rule in Section 401(k)(2)(D)(ii), an employee with at least 500 hours in each of two consecutive 12-month periods has to be allowed to defer, so a steady part-timer who never approaches 1,000 hours in any single year still ends the one-participant status. It is available to a sole proprietorship, a partnership, an S corporation, or a C corporation.
• SIMPLE IRA. Open to an employer with 100 or fewer employees who earned $5,000 or more from the business in the preceding year, the section 408(p) headcount test.
• Defined-benefit or cash-balance plan. Open to any entity, but its economics only make sense for a business with high, stable net income, often above $250,000, where the owner is meaningfully older than the staff and wants to contribute well past what a defined-contribution plan can hold.

The narrower comparison between the two most common owner-only choices, a SEP-IRA and a Solo 401(k), is its own piece, in Solo 401(k) vs. SEP-IRA.

What it requires

Headcount and contribution goals sort the four vehicles fairly predictably:

A SEP-IRA is adopted with Form 5305-SEP or a prototype document, and can be funded as late as the business return's due date including extensions, making it the easiest plan for a late decider to still use for the prior year. That flexibility carries a coverage condition under section 408(k): if the owner contributes for themselves, every employee at least 21 years old, who worked for the business in three of the five years before the current one, and who earned at least the SEP's minimum compensation floor, $800 for 2026, has to receive a contribution too, at the same percentage of compensation the owner used. The employer contribution is the lesser of 25 percent of compensation or the section 415(c) ceiling for the year, $72,000 for 2026, but that 25 percent figure is the corporate or partnership rate. A sole proprietor applies a different rate to a different base: 20 percent of net self-employment earnings after the deduction for one half of self-employment tax, not 25 percent of compensation, the arithmetic set out in IRS Publication 560's rate worksheet.

Under sections 401(a) and 401(k), a Solo 401(k) has to be established by December 31 of the plan year for the employee-deferral piece to count. SECURE 2.0 Act section 317 is generally read to let a sole proprietor adopt the plan later, up to the unextended return due date, and still defer for the prior year, though I would confirm the plan document supports that before relying on it. The employer, profit-sharing side has more room and can be funded as late as the extended return due date. The two pieces stack: an employee deferral, $24,500 for 2026, plus an employer contribution of 25 percent of compensation, 20 percent for a sole proprietor, bounded together by the same $72,000 section 415(c) ceiling. A catch-up sits on top of that ceiling rather than inside it: $8,000 more at 50 or older, or $11,250 more at age 60 to 63. Section 414(v)(7) adds a condition on how it is made rather than whether: a participant whose prior-year FICA wages from the sponsoring employer exceeded an indexed threshold, $150,000 of 2025 wages for a 2026 catch-up, has to make it as Roth. Once plan assets pass $250,000, the plan has to file Form 5500-EZ annually.

A SIMPLE IRA is adopted with Form 5304-SIMPLE, where each employee picks a custodian, or Form 5305-SIMPLE, where the employer does, by October 1 of the plan year for an existing business. The employer must fund it every year using one of two fixed formulas: matching dollar for dollar on the first 3 percent of each employee's compensation, reducible to 1 percent in no more than 2 of 5 years, or a flat 2 percent nonelective contribution for every eligible employee regardless of whether that employee defers anything, computed on compensation capped at $360,000 for 2026 under section 401(a)(17). A SIMPLE also carries an exclusive-plan rule under section 408(p): the employer generally cannot maintain any other qualified retirement plan the same year.

A defined-benefit or cash-balance plan needs an enrolled actuary from the start and has to be adopted by the business's return due date, including extensions. It is not measured against the $72,000 defined-contribution ceiling at all; it targets an annual retirement benefit instead, capped at $290,000 for 2026 under section 415(b), which lets it absorb a far larger deductible contribution for an older owner in a single year. Annual funding is not optional: falling short of the minimum triggers an excise tax under section 4971. Stacking a cash-balance plan on a 401(k) and profit-sharing plan is a common design once income supports it, and getting the combined number right is the actuary's calculation, not a do-it-yourself estimate.

What you need to document

An annual eligibility census for a SEP

A dated review of every employee's age, hire history, and compensation, run every year the owner contributes. The most common way a SEP unravels is an owner who funds themselves while overlooking a long-tenured or part-time employee who quietly hit the three-of-five-year test.

An hours log for anyone near the Solo 401(k) line

A running count of hours worked by anyone other than the owner or a working spouse, kept year over year rather than one year at a time. Crossing 1,000 hours in a single year converts a one-participant plan into a fully covered plan, and so does 500 hours in each of two consecutive years under the long-term part-time rule. Neither is something to discover after the fact.

The plan document and every deferral election date

The plan's actual adoption date, and for a Solo 401(k) relying on the SECURE 2.0 late-adoption relief, the date the deferral election was signed, since the relief turns on the plan document's language, not the statute alone.

The SIMPLE's contribution formula and each participant's start date

Which formula, match or nonelective, was elected for the year, and the date each participant's SIMPLE participation began. Moving money to anywhere other than another SIMPLE inside a participant's first two years of participation triggers a 25 percent tax under section 72(t)(6), not the ordinary 10 percent that applies afterward.

The actuary's annual certification, for a DB or cash-balance plan

The enrolled actuary's certification and Schedule SB for the year, and the assumptions behind them, because overstated actuarial assumptions invite challenge and missing the mandatory minimum funding triggers the excise tax under section 4971.

Where it goes wrong

Every one of these failure modes shows up as a plan-level defect discovered well after the contribution was already deducted, which is what makes documentation the real defense rather than an afterthought.

The recurring mistakes

• A SEP coverage failure. This is the most common failure on this page: the owner funds their own SEP while omitting an eligible long-tenured or part-time employee, which disqualifies the SEP and unwinds the owner's own deduction along with it.
• A Solo 401(k)'s phantom employee. Hiring a single non-spouse common-law employee who works more than 1,000 hours converts the plan from one-participant to fully covered, retroactively, bringing coverage testing, top-heavy minimums, and a Form 5500 filing with it. The long-term part-time rule does the same at 500 hours in each of two consecutive years, which is the version that catches people, because nobody watching a 1,000-hour line sees it coming. Worth tracking as headcount grows rather than discovering at filing time.
• The self-employed rate error. Applying the corporate 25 percent figure to a sole proprietor's Schedule C earnings, instead of the 20 percent net-earnings computation the self-employed rate worksheet actually calls for, overstates the deduction.
• The top-heavy trap on a combo plan. A safe-harbor 401(k) satisfies the top-heavy rules under section 416 only when the safe-harbor contribution is the sole employer contribution the plan makes; layering in the discretionary profit-sharing contribution that gives the combo plan its higher ceiling can bring the 3 percent top-heavy minimum for non-key employees back into play.
• A SIMPLE's exclusive-plan violation. Maintaining any other qualified plan for the same year a SIMPLE is already running voids the SIMPLE, not the newer plan. The one carve-out is the Section 408(p)(11) mid-year replacement, where a safe harbor 401(k) takes over the day after the SIMPLE is terminated.
• A SIMPLE's two-year rollover trap. Moving money to anywhere other than another SIMPLE inside a participant's first two years generally triggers the 25 percent additional tax, well above the standard 10 percent that applies everywhere else. Section 72(t)(6)(B) waives it in one case: where the employer terminated the SIMPLE and set up a 401(k) or 403(b), and the money rolls into that plan.
• Underfunding or overfunding a DB or cash-balance plan. Missing the mandatory annual funding triggers the section 4971 excise tax on the shortfall. Overfunding has its own failure mode: a reversion of excess assets to the employer at plan termination is taxed as income and carries an excise tax under section 4980 that can reach 50 percent on top of it.

A situation where this comes up

The version I see most often is a Florida S-corp with a single owner and no other employees, still funding a SEP-IRA years after the business could comfortably support more, simply because the SEP is what got set up when the business was younger. Nothing about the business has to change for a Solo 401(k) to become the better fit; the only real cost is opening the new plan and directing the deferral correctly.

The version that changes the analysis is the moment the business hires its first real employee. A SEP funding the owner at a healthy percentage suddenly has to fund that same percentage for the new hire too, which is usually the point where a SIMPLE, or a safe-harbor 401(k) with profit sharing, starts to look far cheaper per dollar the owner keeps. The small-employer retirement-plan startup credit is worth checking at the same time: it only applies to a plan covering at least one non-owner, non-highly-compensated employee, a detail I cover separately in the startup-credit strategy.

The situation that concerns me is the reverse: a defined-benefit or cash-balance plan adopted because someone heard it allows a much larger deduction, before an actuary has modeled what the business's income can sustain in a bad year. A plan is easy to start and expensive to unwind once the funding obligation is in place; running the numbers with a credentialed actuary before adopting costs far less than discovering afterward that it does not fit the business.