Retirement contributions are one of the most efficient tax reduction tools available to small business owners — they reduce your taxable income dollar-for-dollar, which means savings on both federal income tax and self-employment tax. Most business owners contribute far less than they're eligible to. Here's why, and what you can do about it.
The Basic Mechanism
Traditional retirement contributions — to a 401k, SEP-IRA, SIMPLE IRA, or similar account — reduce your adjusted gross income in the year you make the contribution. That reduction flows through to your taxable income.
If you're in the 22 percent federal income tax bracket and you contribute $10,000 to a retirement plan, your federal tax bill decreases by $2,200. Retirement contributions do not reduce self-employment tax — it is calculated on your net earnings before the contribution — so the savings come from income tax.
The money doesn't disappear — it goes into a retirement account that grows tax-deferred until withdrawal. You've deferred the tax on that income until retirement, when you may be in a lower bracket.
The Options for Self-Employed People
W-2 employees have access to employer-sponsored 401k plans. Self-employed people and business owners have several options that often allow larger contributions.
Which retirement account fits depends on your income, entity, and cash flow. We can help you choose one and size the contribution.
Solo 401k (also called Individual 401k)
For self-employed individuals with no full-time employees other than a spouse, the solo 401k allows the highest contribution limits of any available retirement vehicle.
In 2026, contributions can total up to $72,000 if you're under 50, or $80,000 if you're 50 or older with the $8,000 catch-up ($83,250 at ages 60 to 63).
This total has two components. The employee contribution — made in your capacity as the employee of your own business — is up to $24,500 in 2026 ($32,500 with the age-50 catch-up). The employer contribution — made in your capacity as the employer — can be up to 25 percent of W-2 wages paid to yourself (for S-Corp owners) or approximately 20 percent of net self-employment income (for sole proprietors).
The plan must be established by December 31 of the year for which you're making contributions. The contributions themselves can be made up to the tax filing deadline, including extensions.
SEP-IRA
The SEP-IRA (Simplified Employee Pension) allows contributions up to 25 percent of compensation (for employees) or approximately 20 percent of net self-employment income (for sole proprietors), up to a maximum of $72,000 in 2026.
The advantage of the SEP-IRA is that it can be established and funded up to your tax filing deadline, including extensions. If you file an extension to October 15, you can open and fund a SEP-IRA all the way to October 15 of the following year. This makes it more flexible than a solo 401k for people whose income is hard to predict.
The limitation: the SEP-IRA only allows employer-side contributions. The solo 401k allows both employer and employee contributions, which enables higher total contributions at lower income levels.
SIMPLE IRA
The SIMPLE IRA is designed for small businesses with employees. It allows employee contributions up to $17,000 in 2026, with a $4,000 catch-up for those 50 and older, plus required employer matching contributions. The contribution limits are lower than a solo 401k, but the structure works for businesses with a small number of employees.
Traditional IRA
Anyone with earned income can contribute to a traditional IRA. The 2026 limit is $7,500, with a $1,100 catch-up for those 50 and older.
The deductibility of traditional IRA contributions phases out for people who have access to a workplace retirement plan and whose income exceeds certain thresholds. For self-employed people without any other retirement plan, contributions are fully deductible.
IRA contributions for a given tax year can be made up to April 15 of the following year.
The Compounding Effect of Consistent Contributions
The tax savings are valuable in the year of contribution. But the long-term financial effect of consistent contributions is the more significant consideration.
A business owner who contributes $30,000 per year from age 35 to 65, earning a 7 percent average annual return, accumulates approximately $2.8 million. That's from consistent contributions made easier to afford because each one reduces the current year tax bill.
The business owners who build significant retirement wealth are the ones who establish the habit of maximizing contributions early and maintain it through good years and lean years.
The Practical Barriers
Most business owners don't maximize their contributions because of cash flow — the tax benefit is real but requires money going out of the business today. In a year where cash is tight, retirement contributions are an easy thing to defer.
The most effective approach is treating retirement contributions as a fixed expense — the same way you'd treat payroll or rent — rather than something that happens with whatever's left at year end. Funding contributions monthly, or at least quarterly, makes them more manageable than a single large payment in March.
Year-End Planning
The most common question we get about retirement contributions is in November and December, when business owners are looking at a good year and trying to decide how much to contribute to reduce their tax bill.
The honest answer is: the earlier in the year you plan for this, the better your options. If you're asking the question in December, you can still fund a solo 401k employee contribution or make a SEP-IRA contribution — but you've lost the flexibility you would have had with six months of runway.
Timing is most of the game here. We raise retirement contributions in our mid-year review conversations, because knowing how the year is tracking by June or July gives you time to fund them without a cash crunch while maximizing the tax benefit.