Retirement Plan Options for a Sole Proprietor
Maximize your tax-advantaged retirement savings as a sole proprietor. Understand the key differences in contribution rules and plan features to choose wisely.
As the owner of an unincorporated business, you are a sole proprietor. This position means you are both the employer and the employee, giving you direct control over your business’s financial decisions, including retirement planning. The choices available offer a range of contribution levels, features, and administrative requirements tailored to different income levels and business complexities.
The SEP IRA
A Simplified Employee Pension, or SEP IRA, is a retirement plan that allows a sole proprietor to make contributions for themselves. The plan is defined by its straightforward structure, which involves only employer-funded contributions. There is no separate employee contribution component, which simplifies the calculation and funding process.
For 2025, you can contribute up to 25% of your eligible compensation, with a maximum contribution of $70,000. For a sole proprietor, the calculation is not as simple as taking 25% of your net profit from Schedule C. You must first calculate your net adjusted self-employment income by subtracting one-half of your self-employment tax from your net profit. The 25% limit is then applied to this adjusted figure, which effectively works out to be about 20% of your unadjusted net profit.
For example, with $100,000 in net profit, you would first subtract half of your self-employment tax to find your net adjusted income before applying the 25% contribution limit. You can establish and fund a SEP IRA for a given tax year up until the due date of your business’s tax return, including extensions.
The Solo 401(k)
The Solo 401(k), also known as an individual 401(k), is a retirement plan designed specifically for self-employed individuals with no employees, other than a spouse. This plan is distinguished by its dual-contribution structure. This feature often permits a higher total contribution compared to other plans, especially at lower and moderate income levels.
As the employee, you can make salary deferral contributions. For 2025, this amount is up to 100% of your compensation, capped at $23,500. If you are age 50 or older, you can make an additional catch-up contribution of $7,500, but a higher limit of $11,250 applies to those aged 60 to 63.
In your role as the employer, you can make a separate profit-sharing contribution. This contribution is limited to 25% of your net adjusted self-employment income. For 2025, the total combined contribution limit is $70,000, or $77,500 if you are age 50 or older (and even higher for those 60-63). This structure allows you to potentially reach the maximum contribution limit with less income than would be required under a SEP IRA.
A Solo 401(k) offers the option for Roth contributions on the employee salary deferral portion. Making a Roth contribution means you pay taxes on the money now, and in exchange, qualified distributions in retirement are tax-free. Another advantage is the potential to take a loan from your plan balance, a feature not available in SEP or SIMPLE IRAs.
The plan must generally be established by December 31 of the tax year for which you want to make contributions. However, both the employee and employer contributions can be made up until your business’s tax filing deadline for that year, including extensions.
The SIMPLE IRA
The Savings Incentive Match Plan for Employees, or SIMPLE IRA, is another retirement plan option available to sole proprietors. This plan is often considered by business owners who may anticipate hiring employees in the future, as it is designed for small businesses with 100 or fewer employees.
As the employee, you can make contributions up to a set dollar limit each year. For 2025, the employee contribution limit is $16,500, with an additional $3,500 catch-up contribution for those age 50 and over.
The employer contribution component is mandatory in a SIMPLE IRA. You have two choices for how to make this contribution for yourself. The first option is a matching contribution, where you match your employee contribution dollar-for-dollar up to 3% of your compensation. The second option is a non-elective contribution, where you contribute 2% of your compensation, regardless of whether you made an employee contribution. The compensation limit for calculating this contribution in 2025 is $350,000.
If you establish a SIMPLE IRA and later hire eligible employees, you must make the same employer contribution for them as you do for yourself. The deadline to establish a new SIMPLE IRA is October 1 for the current tax year, and employer contributions are due by the tax filing deadline, including extensions.
Defined Benefit and Cash Balance Plans
For high-income sole proprietors, particularly those who are older and looking to save a very large amount for retirement in a short period, Defined Benefit and Cash Balance Plans present an advanced strategy. Unlike the previously mentioned plans, which are “defined contribution” plans based on annual contribution limits, these are “defined benefit” plans.
An actuary calculates the annual contribution required to fund the promised future retirement benefit. This calculation takes into account factors like your current age, your expected retirement age, and projected investment returns. Because the goal is to fund a specific pension-like payout, the annual tax-deductible contributions can often be significantly higher than the limits for SEP IRAs or Solo 401(k)s, sometimes exceeding $100,000 or more per year.
A Cash Balance Plan is a type of defined benefit plan that has characteristics of a defined contribution plan. It expresses the promised benefit in terms of a hypothetical account balance, which grows with annual contribution credits and a guaranteed interest crediting rate. This structure can make the plan easier to understand than a traditional pension formula.
These plans are more complex and have higher administrative costs than other self-employed retirement plans. They require the ongoing services of an actuary to perform the annual calculations and ensure the plan remains compliant with IRS funding rules. For 2025, the maximum annual benefit that a plan can be designed to pay out is limited to $280,000 or 100% of the participant’s average compensation for their highest three consecutive years, whichever is less. These plans are best suited for consistently profitable businesses that can support the mandatory funding obligations.
Plan Establishment and Administration
The first step in setting up any retirement plan is to select a financial institution to act as the plan custodian. Most major brokerage firms, mutual fund companies, and banks offer accounts for self-employed retirement plans. The process involves completing a plan adoption agreement, which is a standardized document that formally establishes the plan and outlines its operating rules.
Once the plan is established, your primary administrative duty is to fund it. Contributions are made by transferring money from your business bank account to the retirement account at the custodian.
A specific administrative requirement applies to Solo 401(k) plans. If the total assets in your Solo 401(k) plan exceed $250,000 at the end of the plan year, you are required to file Form 5500-EZ with the IRS. This form is an annual informational return that reports details about the plan’s assets and activities. The filing deadline is seven months after the end of the plan year, which is July 31 for a calendar-year plan, with an extension available. This filing is also required in the final year of the plan, regardless of the asset value.