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Retirement Plans for Small Service Business

Reference Process Updated Jul 4, 2026

Why this matters

Retirement benefits are an increasingly important hiring + retention tool - especially for techs in their 30s + 40s who are planning long-term careers. Federal SECURE Act 2.0 (2022) + state mandates make retirement plan setup easier + sometimes mandatory. Tax advantages for both employer + employee are real. Most small contractors offer NOTHING + lose talent to competitors who do. Adding even a modest retirement plan is a competitive differentiator + a tax efficiency win.

The four small-business retirement plan options

1. SEP-IRA (Simplified Employee Pension)

  • Easiest to set up (one IRS form)
  • Employer ONLY contributes (employees can't add)
  • Same percentage for ALL employees including owner
  • Employee always 100% vested

2. SIMPLE IRA (Savings Incentive Match Plan)

  • Easy to administer
  • Employees contribute + employer matches
  • Employer match: 3% of comp OR 2% non-elective for all
  • 100% vested immediately

3. Solo 401(k) (one-participant 401(k))

  • For owner-only OR owner + spouse businesses
  • Higher contribution limits than SEP / SIMPLE
  • PLUS employer profit-sharing: up to 25% of comp

4. Traditional 401(k) (with employees)

  • Most popular among employee-having businesses
  • Employee + employer contributions
  • Employer matching: typical 3 - 6%
  • Vesting schedules allowed (e.g., 5-year graded)
  • Administration is more complex

Decision tree

Owner-only / spouse business: Solo 401(k) wins on contribution limits.

1 - 5 employees, want max simplicity: SEP-IRA.

1 - 25 employees, want employee buy-in: SIMPLE IRA.

5+ employees, want serious retention tool: Traditional 401(k).

State-mandated programs: CalSavers, Illinois Secure Choice, OregonSaves, others - if your state requires participation + you don't have a plan, you may be required to enroll employees in state-run program.

SEP-IRA in detail

Setup: IRS Form 5305-SEP (one page); open SEP-IRA at brokerage; no annual filing.

Contributions: Employer ONLY; up to 25% of W-2 wages OR 20% of net self-employment income; the IRS sets an annual dollar cap each year; same % for all eligible employees (21+, worked 3 of last 5 years, earned above a small IRS-set minimum).

Example: Owner earning a strong six-figure salary + 4 employees each earning roughly half that. Owner takes the max 20% contribution rate → must contribute that same 20% rate to each employee's wage. Total employer cost scales with headcount + average wage, and the whole amount is tax-deductible.

Limitation: only employer can contribute.

SIMPLE IRA in detail

Setup:

  • IRS Form 5304-SIMPLE OR 5305-SIMPLE
  • Open SIMPLE IRA accounts at brokerage
  • Notify employees + provide Salary Reduction Agreement
  • Annual filing: minimal (no 5500)

Contributions:

  • Employer must do one of:
    • 3% match on first 3% of compensation employee defers (most common)
    • 2% non-elective contribution to ALL eligible employees regardless of whether they defer

Example:

  • Owner takes a solid six-figure income; several employees average roughly half that
  • Owner defers the max employee contribution + gets the 3% match, landing a meaningful combined amount into the account
  • Employees who defer 3% get a 3% match at their own smaller contribution level
  • Employees who defer 0% get 0% match (some plans use 2% non-elective which avoids this)
  • Total employer cost: depends on participation

Limit + restriction: 100% vested immediately. Cannot have other retirement plan simultaneously. 100-employee maximum.

Solo 401(k) in detail

Owner-only OR owner + spouse. Setup at brokerage (Fidelity, Schwab, Vanguard, Empower).

Contribution limits: employee deferral plus an age-50+ catch-up amount, set annually by the IRS. Employer profit-sharing up to 25% of W-2 OR 20% self-employment. The combined max (employee deferral + employer profit-sharing) runs meaningfully higher than the SEP-IRA max at the same income, which is the whole appeal of Solo 401(k) over SEP for an owner-only business.

Example: Owner takes a solid W-2 salary from an S-Corp. Deferring the max employee amount + adding employer profit-sharing on top reaches the combined cap well before a SEP-IRA would at the same salary. Spouse on payroll doubles capacity.

Traditional 401(k) in detail

Setup:

  • Plan document creation (provider OR third-party administrator)
  • Plan enrollment process
  • Annual Form 5500 filing (provider handles)

Contributions (2025):

  • Employer match: typical 3 - 6% of comp (you design)
  • Profit-sharing: additional discretionary employer contribution

Vesting schedules (employer match):

  • Immediate (most generous)
  • Graded (e.g., 20% per year over 5 years)
  • Cliff (e.g., 100% after 3 years)

Vesting is retention tool - employee leaving before vesting forfeits employer match.

Administration:

  • Annual nondiscrimination testing (HCE vs non-HCE balance)
  • Annual Form 5500 filing
  • Safe harbor designs available to avoid testing

For 10+ employee operations: 401(k) is the standard. Significant admin investment.

SECURE Act 2.0 + small business credit

The SECURE Act 2.0 (2022 + phase-in) added employer tax credits:

  • Startup credit: covers a meaningful share of setup cost for the first 3 years for businesses establishing a new retirement plan with 1 - 50 employees
  • Auto-enrollment credit: a modest flat annual credit for plans with auto-enrollment
  • Employer contribution credit: a per-employee annual credit for the first 5 years

These credits significantly reduce small-employer cost of plan setup + early contributions. Talk to CPA about claiming.

State-mandated programs

Several states require employer enrollment in state-run plans OR offer of qualified private plan:

  • CalSavers (California, 2022 - 2024 rollout)
  • Illinois Secure Choice
  • OregonSaves
  • MyCTSavings (Connecticut)
  • MarylandSaves
  • Others added each year

If state has mandated program + you don't offer qualified retirement plan, you may be required to enroll employees in state plan. State plans typically don't include employer contributions but are simpler than full 401(k).

Confirm your state's rules. Penalty for non-compliance varies.

Tax treatment

Employer contributions (any plan):

  • Tax-deductible to business
  • No payroll tax on contributions
  • Reduces W-2 wages reported (employer match doesn't go on W-2)

Employee contributions (401(k), SIMPLE):

  • Pre-tax: reduces current taxable income
  • Tax-deferred growth
  • Taxed at withdrawal

Roth options (some plans):

  • After-tax contribution
  • Tax-free withdrawal
  • Important for younger employees

Implementation roadmap

For a 1 - 5 employee service contractor:

Year 1: SEP-IRA OR SIMPLE IRA (start simple)

Year 2 - 3: evaluate participation + cost

Year 4+: consider 401(k) if growth + retention warrant complexity

For solo / spouse business: start with Solo 401(k) immediately if income supports contributions.

The single most-overlooked retirement decision for a profitable solo contractor (no employees) is the SOLO 401(k). Most CPAs default-recommend SEP-IRA because it's simpler. But Solo 401(k) allows employee deferral PLUS employer profit-sharing - significantly higher contribution capacity at same income. For a solidly profitable owner at the same six-figure income, Solo 401(k) reaches a meaningfully higher cap than SEP-IRA alone, purely from stacking the employee-deferral piece on top of the same profit-sharing formula. That extra annual contribution compounds substantially over 20 - 30 years. The setup is no more complex; the savings are real. Ask your CPA about Solo 401(k) specifically.

References

  • IRS Publication 560 (Retirement Plans for Small Business)
  • IRS Form 5305-SEP, 5304-SIMPLE
  • SECURE Act 2.0 provisions
  • State retirement program websites (CalSavers, etc.)
  • Manuall internal: Health Insurance Options for Small Business, Payroll Setup for Service Business

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