Publication 560 Summarized — Retirement Plans for Small Business

Publication 560, Retirement Plans for Small Business, is the IRS guide for owners who want to set money aside for retirement through a business rather than a personal IRA alone. If you run a sole proprietorship, a partnership, or a small corporation, this is the document that lays out your real options in plain detail. The publication 560 retirement plans for small business framework breaks down into three main plan families that come up over and over: the SEP IRA, the SIMPLE IRA, and the qualified plan group, which includes the solo 401k and defined-benefit plans. Each one has a different ceiling on what you can put away, a different setup process, and a different amount of paperwork attached. Reading the publication once before you open anything saves you from picking the plan that looks easiest instead of the plan that actually fits.

The reason this matters is money. A personal traditional IRA caps your yearly contribution at a few thousand dollars. A business retirement plan can let you set aside far more, and the contribution comes out of business income, which lowers the taxable profit that flows to your return. For a freelancer reporting income on Schedule C of Form 1040, that difference can be the gap between a small deduction and one worth tens of thousands of dollars in a strong year. The retirement account does double duty. It builds your nest egg and it trims this year’s tax bill at the same time, which is rare among tax moves.

Here is who should be reading this. A self-employed person with no employees has the widest set of choices and usually the best deal, because the solo 401k is open to them and it allows two kinds of contributions stacked together. A small employer with a handful of staff has fewer options that stay cheap, because once you add workers, coverage rules require you to put money in for them too. And a high earner who has already filled up every other account and still wants a larger deduction starts looking at defined-benefit plans, which can permit very large yearly contributions for someone with steady, high profits and a few years left before retirement.

Publication 560 also explains the mechanical pieces people forget about. It covers when contributions are deductible to the business, how the deduction interacts with self-employment tax for someone who files Form 1040, what deadlines apply to setting up and funding each plan, and when a plan grows large enough to trigger an annual return called Form 5500. It also runs through the worksheets that turn your net business profit into the actual dollar amount you are allowed to contribute, which is not the same as your gross income. None of these details are obvious from the account-opening screen at a brokerage, which is exactly why the publication exists.

One thing the publication does not do is pick the plan for you. It describes the rules and leaves the call to you. The choice depends on your income, whether you have employees, how much you want to contribute, and how much administration you are willing to take on. A plan that is perfect for a solo consultant pulling six figures is the wrong plan for a small shop with four part-time workers. We walk clients through that decision in our tax strategy consulting work, because the right answer changes as the business changes. If you have employees now or expect to add them soon, read the coverage sections closely before you commit to anything, since switching plans later is more work than choosing well the first time. The plan you open this year quietly shapes how much you keep for the next decade, so it deserves more than a five-minute decision.

The SEP IRA is the plan most freelancers and one-person businesses reach for first, and Publication 560 spends a good deal of space on it for that reason. SEP stands for Simplified Employee Pension, and the name is honest. There is no annual government filing, no plan document headache, and you can open one at almost any brokerage in an afternoon. For someone who wants a real deduction without hiring an administrator or running annual tests, it is the path of least resistance, and it stays out of your way the rest of the year.

Here is the mechanism. The SEP is funded entirely by the employer, which for a self-employed person means funded by you, out of business income. The contribution limit is built around a percentage of compensation. For an employee with a W-2, that ceiling is 25 percent of pay. For a self-employed owner reporting on Schedule C of Form 1040, the math works out to roughly 20 percent of net self-employment earnings after you subtract the deductible half of self-employment tax. The percentage looks lower for the owner because the calculation runs on a different base, and Publication 560 walks through the worksheet step by step so you do not guess at it. There is also an annual dollar cap that sits on top of the percentage, so very high earners hit a ceiling regardless of the math. Do not rely on a remembered figure for that cap. Check the current-year number in the publication before you fund, because it shifts most years.

A worked example shows the appeal. Say a freelancer has 100,000 dollars of net self-employment income for the year. Running the SEP calculation at roughly 20 percent of the adjusted base lands somewhere near 18,500 dollars that can go into the account. That whole amount reduces the income that flows to Form 1040, so at a combined marginal rate the tax savings are real and immediate. The money then grows tax-deferred until retirement, compounding without a yearly tax drag the way a taxable brokerage account would face.

That last point is where the common mistake lives. A SEP follows traditional-IRA tax rules, which means the money is not tax-free in retirement. You deducted it going in, so it is taxable when you take it out. People sometimes treat a SEP like a Roth and assume the withdrawals are free, then get surprised by a tax bill decades later when the distributions start. The IRS lays out the distribution rules in Publication 590-A, and they mirror the traditional-IRA treatment, so plan for the eventual tax rather than pretending it is not coming.

The other trap is employees. If your business has eligible workers, the SEP requires you to contribute the same percentage of compensation for them that you contribute for yourself. Put 20 percent away for your own account and you owe 20 percent of each eligible employee’s pay too. For a solo operator that is irrelevant. For a growing shop it can get expensive fast, and it is the reason many owners move off the SEP once they hire their first real employee. One genuinely useful SEP feature is timing. You can set up and fund a SEP all the way up to your tax filing deadline, including extensions, which makes it a rare late-planning move. If you reach filing season and realize you owe more than expected, a SEP contribution can still cut the bill after the year has closed. We use that lever often during individual tax return preparation when a client’s numbers come in higher than planned. Open it, fund it, claim it, all after December 31. Few tax moves still work that far past the calendar, and that alone keeps the SEP popular.

These two plans solve different problems, and Publication 560 treats them as separate animals for good reason. The SIMPLE IRA is built for a small employer who has staff and wants a low-cost plan that includes them. The solo 401k is built for an owner with no employees who wants the largest possible contribution. Mixing them up leads people to pick the plan that fits their neighbor instead of their own business, and that mismatch can quietly cost you either money or flexibility.

Start with the SIMPLE IRA. SIMPLE stands for Savings Incentive Match Plan for Employees, and it is aimed at smaller businesses with limited headcount. Employees can defer part of their salary into the account, and the employer has to either match those deferrals up to a set percentage or make a flat contribution for everyone who qualifies. The employer contribution is mandatory, not optional, which is the trade-off for how cheap and easy the plan is to run. The contribution limits are lower than a 401k, so a high-earning owner cannot stuff as much in during a strong year. But if you have a few employees and want a real retirement benefit without a plan administrator and annual testing, the SIMPLE IRA does the job at a price most small shops can carry. The rules and the funding deadlines live in Publication 560, and they are worth reading before you commit, because the mandatory match is a recurring cost.

Now the solo 401k, sometimes called a one-participant 401k. This plan is only for an owner with no employees, possibly plus a spouse who works in the business. What makes it powerful is that it lets you contribute in two capacities at once. You make an employee salary deferral, and then on top of that you make an employer profit-sharing contribution. Stacking the two often produces a larger total than a SEP would allow at the same income, which is the whole reason high-earning solo operators choose it. There is also a catch-up contribution allowed for those age 50 and older, and many providers offer a Roth option inside the plan so part of your savings can grow tax-free for withdrawal later.

The two-bucket structure is easiest to see in numbers. Take that same freelancer with 100,000 dollars of net self-employment income. A SEP might cap the contribution near 18,500 dollars at roughly 20 percent of the adjusted base. With a solo 401k, the owner can first make the employee deferral, then add the profit-sharing piece on top, and the combined figure can run meaningfully higher than the SEP result at the identical income. That extra room is the entire point, and for a solo operator with a good year it can mean thousands of additional dollars sheltered. Because the exact deferral and overall caps change year to year, confirm the current numbers in Publication 560 rather than trusting a figure you saw last spring.

The catch with the solo 401k is the no-employees rule. Hire one common-law employee who meets the eligibility thresholds and the plan stops being a one-participant plan, which pulls in coverage and nondiscrimination requirements and changes everything about how you run it. There is also more administration than a SEP, and once plan assets cross a threshold you may owe an annual Form 5500 filing. Both contributions still reduce what flows to Form 1040, so the deduction is real, but the bookkeeping is heavier and the deferral has an earlier deadline. Clean records make this far less painful, which is part of why we pair plan setup with steady bookkeeping so the contribution math is right when filing season arrives. Pick the plan that matches your headcount today and your hiring plans for the next year or two, not the one a friend in a different situation happens to use.

Yes, and the deduction is the main reason these plans exist. When your business contributes to a SEP, a SIMPLE IRA, or a qualified plan like a solo 401k, that contribution is deductible to the business and lowers the taxable income that reaches your return. Publication 560 ties the whole structure to this point. For a self-employed person, the contribution reduces the net profit that flows from Schedule C of Form 1040 into your taxable income, so you feel it directly on the bottom line of Form 1040. For a corporation, the contribution comes off the business return instead, but the principle is the same: money set aside for retirement does not get taxed as current income.

Think about what that does at the margin. If you are in a combined federal and state bracket and you put away that 18,500 dollar SEP contribution from our 100,000 dollar freelancer, you are not just saving for retirement. You are cutting this year’s tax bill by a meaningful slice of that contribution, with the exact savings set by your marginal rate. The money you would have handed to the government instead sits in an account with your name on it, growing tax-deferred. That is the trade business owners keep choosing: pay yourself first, defer the tax, let it compound over the years until you draw it down.

Deadlines are where the plans split, and getting them wrong costs you the deduction. The SEP is the most forgiving by a wide margin. You can establish and fund a SEP up to your tax filing deadline, including extensions. File an extension and you have until the fall to open the account and put the money in, then claim it on the return for the prior year. That makes the SEP a genuine late-planning tool, one of the few moves still available after the calendar year has closed. We lean on it during individual tax return preparation when a client’s final numbers run higher than expected and they want to soften the hit before they sign the return.

The 401k and SIMPLE plans are stricter. A solo 401k generally has to be established by the end of the business year to make employee deferrals for that year, even if the employer profit-sharing piece can be funded later. The SIMPLE IRA has its own setup window earlier in the year and its own funding rules for employer and employee money. Because the specifics shift and the consequences of missing a window are real, check the deadline tables in Publication 560 before you count on funding a plan after year-end. Assuming every plan has the SEP’s generous timing is a common and expensive error, and it usually surfaces in March when there is no longer time to fix it.

A few more rules deserve attention. The deductible contribution interacts with self-employment tax, and the worksheets in the publication handle that interaction so you do not double-count or over-contribute. There are dollar caps that limit the deduction no matter how the percentage math comes out, so a very high earner cannot deduct without a ceiling. And once a plan grows past a certain asset level, an annual Form 5500 filing can apply, which is an administrative duty separate from the deduction itself. The deduction lives or dies on accurate records of net earnings, so the cleaner your books, the cleaner the contribution calculation. Sloppy bookkeeping is the quiet reason some owners under-contribute or over-contribute and then have to unwind it later, which is a hassle nobody wants. If you are not sure which plan gives you the biggest deduction for your situation, that is the conversation to have well before the filing deadline, while you still have room to act.

Adding employees is the single biggest event that reshapes your retirement plan choice, and Publication 560 devotes real attention to it. As long as you are a true one-person business, you have the run of every plan, including the solo 401k with its generous two-bucket contribution. The moment you bring on a common-law employee who meets the eligibility thresholds, the rules tighten, and a plan that was cheap and simple can become costly or off-limits. Plenty of owners learn this the hard way, after the first hire is already on payroll.

The reason is coverage and nondiscrimination. The tax code does not let an owner build a fat retirement benefit for themselves while leaving the staff out. Once you have eligible employees, you generally have to include them on comparable terms. With a SEP, that means the same contribution percentage you set for your own account applies to every eligible worker. Decide to put away 20 percent for yourself and you owe 20 percent of each qualifying employee’s compensation as well. For a solo operator that line is meaningless. For a business with several employees it is a large and recurring cost, and it is exactly why many owners move off the SEP once they start hiring more than a person or two.

The solo 401k reacts even more sharply. It is defined as a one-participant plan, so it only works for an owner alone or an owner plus a working spouse. Hire one eligible common-law employee and the plan no longer qualifies as a one-participant plan. At that point you are into the world of full coverage testing, nondiscrimination rules, and heavier administration, which is a different commitment than the simple setup you started with. The SIMPLE IRA, by contrast, was designed for small employers from the start, so it absorbs employees more gracefully, though it still requires that mandatory employer match or contribution for everyone who qualifies. Publication 560 lays out which plan handles a growing headcount best, and it is worth a careful read before you scale up.

Now the mistakes. The most common one is the SEP owner with employees who does not realize the equal-percentage rule applies to the staff. They fund their own account at a high percentage, never set anything aside for the workers, and then learn they have a funding obligation they never budgeted for. That is a correction with real cost attached, both in dollars owed and in cleanup time. The second frequent error is treating any of these accounts as tax-free in retirement. A SEP and a traditional solo 401k follow traditional-IRA distribution rules, which means you deducted the money going in and you owe tax when you pull it out. The withdrawal mechanics sit in Publication 590-A, and they are the opposite of a Roth. The third error is a timing miss, assuming every plan can be funded after year-end the way a SEP can, which is not true for 401k deferrals and trips up more owners than you would expect.

If you have employees or you can see hiring on the horizon, build the plan choice around that fact rather than around your current solo status. Switching plans after you have workers is more work than choosing the right one up front, and it sometimes means unwinding contributions you already made or amending a return. This is the kind of forward-looking call that pays off, because the wrong plan does not just cost you administrative grief, it can lock you into funding obligations that grow with every hire you add. We map plan choice against headcount and growth plans in our tax strategy consulting work, where the goal is a plan that still fits a year or two out. Decide with the next two years in view, not just this one, and the plan will still fit when the business is bigger.