Retirement Plans for Independent Consultants: SEP IRA, Solo 401(k), and Defined Benefit Strategies

The retirement plan is the most powerful tax reduction tool available to an independent consultant. A consultant earning $300,000 who contributes $72,000 to a Solo 401(k) saves approximately $26,600 in income tax (at a 37% marginal rate) while building a retirement account that compounds tax-deferred. The contribution also reduces adjusted gross income, which can affect other tax calculations (the QBI deduction phase-out, the net investment income tax, Medicare premium surcharges). For consultants over 50, the numbers get even better with catch-up contributions and defined benefit plans.

Why does the Solo 401(k) beat the SEP at moderate income?

The difference is the employee deferral. For current guidance, see IRS Retirement Plans for Small Business. The SEP allows contributions only as a percentage of income (effectively 20% for sole proprietors, 25% for S-Corp W-2 salary). The Solo 401(k) adds a flat-dollar employee deferral on top of the percentage-based employer contribution.

The Solo 401(k) also provides a Roth deferral option (the employee portion can be designated Roth, meaning after-tax contributions that grow and withdraw tax-free). The SEP has no Roth option.

The Solo 401(k) must be established by December 31 of the plan year. The SEP can be established up to the tax filing deadline (including extensions), which gives the consultant until October 15 to decide.

When does a defined benefit plan make sense?

A defined benefit plan promises a specific annual retirement benefit and requires annual contributions calculated by an actuary. For an older consultant (55+) with consistently high income, the contribution can be $150,000-$350,000 per year, far exceeding the 401(k) limits.

The trade-off is mandatory annual funding. If the consultant’s income drops, the contribution must still be made (or the plan must be frozen or terminated, which involves administrative costs). For consultants with variable income, the risk of mandatory contributions in a lean year makes the DB plan impractical unless the consultant has other income sources or savings to cover the contribution.

A common strategy: pair a DB plan with a 401(k). The DB plan provides the large deduction in high-income years, and the 401(k) provides a flexible base. If income drops, the DB plan can be frozen while the 401(k) continues with discretionary contributions.

For a 60-year-old consultant earning $500,000 consistently, a DB plan contributing $250,000/year for five years saves approximately $92,500/year in income tax at the 37% rate, sheltering $1,250,000 over the five-year period.

How does S-Corp status affect retirement contributions?

For an S-Corp shareholder-employee, the retirement plan contribution base is the W-2 salary (not the S-Corp distribution). The employer contribution is 25% of W-2 salary. The employee deferral ($23,500 + catch-up) applies against the same salary.

This creates a tension: a lower salary reduces payroll tax but also reduces the retirement contribution limit. A higher salary increases the contribution limit but increases payroll tax.

The optimal salary balances these two effects. For a consultant earning $300,000 with the goal of maximizing both payroll tax savings and retirement contributions, the salary is typically set at $120,000-$150,000. At $150,000 salary: employer contribution = 25% x $150,000 = $37,500. Employee deferral = $23,500. Total = $61,000. Distribution = $150,000 (no payroll tax).

If the salary were set lower ($80,000), the employer contribution would be $20,000, reducing the total contribution by $17,500. The payroll tax savings from the lower salary ($10,710) are partially offset by the lost retirement deduction ($17,500 x 37% = $6,475 in lost tax savings). The net benefit of the lower salary is $10,710 minus $6,475 = $4,235. Whether this trade-off is worth it depends on the consultant’s liquidity needs and retirement savings goals.

What if the consulting firm has employees?

Solo consultants who hire staff (an office manager, a junior consultant, a virtual assistant) must include eligible employees in the retirement plan. This changes the economics:

SEP IRA: The employer contribution percentage must be the same for the owner and all eligible employees. If the owner contributes the effective 20% of net SE income, every eligible employee gets 25% of their salary. For a consultant with one full-time assistant earning $50,000, the employee’s SEP contribution is $12,500.

Safe Harbor 401(k): The employer makes a 3% nonelective contribution (or 4% match). The 3% contribution on a $50,000 salary is $1,500 per employee. This is much less expensive than the SEP’s equal-percentage requirement, and the Safe Harbor eliminates nondiscrimination testing.

Solo 401(k): Not available once the firm has full-time employees (other than the owner and their spouse). The firm must switch to a regular 401(k) with ADP/ACP testing or Safe Harbor provisions.

What are the SECURE 2.0 changes?

Super catch-up for ages 60-63: Beginning in 2025, participants ages 60-63 can defer up to $11,250 (indexed), instead of the standard $7,500 catch-up. For a 61-year-old consultant, the total deferral is $23,500 + $11,250 = $34,750.

Enhanced startup credits: Firms with 50 or fewer employees get a tax credit for plan startup costs (up to $5,000/year for three years) and an additional credit for employer contributions (up to $1,000 per employee). This reduces the net cost of establishing a new plan.

Roth employer contributions: Employers can now designate matching and nonelective contributions as Roth (after-tax, tax-free growth). Previously, only employee deferrals could be Roth. This is useful for consultants who expect their tax rate to increase in retirement.

Auto-enrollment mandate: New plans established after December 29, 2022 must auto-enroll eligible employees at 3-10% (not applicable to plans with no employees, and small businesses with 10 or fewer employees are exempt).

Related guides:

• Solo 401(k) and the Mega Backdoor Roth: How Self-Employed Owners Can Save $70,000+ Per Year

• Revenue recognition for consulting firms, how the cash vs. accrual choice affects year-end planning and retirement contribution timing

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.