Retirement Plans for Franchise Owners: SEP-IRA, Solo 401(k), and Defined Benefit Options

A franchise owner who takes home $200,000 and contributes nothing to a retirement plan pays federal and state income tax on all of it. The same owner who contributes $69,000 to a Solo 401(k) pays tax on $131,000. At a combined 35% marginal rate, that contribution saves $24,150 in the current year and compounds tax-deferred for decades. The math is straightforward, but the plan selection is not. The right retirement plan depends on whether you have employees beyond yourself and your spouse, how your entity is structured (S-corp salary matters enormously here), how much income you want to shelter, and how much administrative cost you’re willing to absorb. Franchise businesses add a layer of complexity because most franchise systems eventually require employees, which eliminates the Solo 401(k) and forces a choice between plans that carry employer contribution obligations. This guide covers every plan type relevant to franchise owners, from the simplest SEP-IRA to defined benefit plans that shelter north of $200,000 per year.

What plans are available with no employees?

If you operate a single franchise location and your only workers are yourself (and possibly your spouse), you have two primary options: the SEP-IRA and the Solo 401(k). Both are tax-deferred plans that reduce current-year taxable income, but they differ in contribution mechanics, limits, and flexibility.

The SEP-IRA (Simplified Employee Pension) allows employer-only contributions of up to 25% of W-2 compensation for S-corp owners, or approximately 20% of net self-employment income for sole proprietors (the exact formula under IRC 404(h) accounts for the self-employment tax deduction). For 2025, the maximum contribution is $70,000. Setup is minimal: a one-page IRS Form 5305-SEP, a brokerage account, and a contribution by the tax filing deadline (including extensions). There is no annual filing requirement with the IRS.

The Solo 401(k), also called an individual or one-participant 401(k), has two contribution components. First, the employee elective deferral: up to $23,500 for 2025 ($31,000 if you are age 50 or older). Second, the employer profit-sharing contribution: up to 25% of W-2 compensation. The combined total cannot exceed $70,000 for 2025 ($77,500 if 50+). The Solo 401(k) requires slightly more paperwork than the SEP (a plan document, though many brokerage firms provide free boilerplate versions), and plans with assets over $250,000 must file Form 5500-EZ annually.

The Solo 401(k) beats the SEP-IRA at moderate income levels because the employee deferral component is a flat dollar amount, not a percentage of compensation. An S-corp owner paying herself a $70,000 salary can defer $23,500 as the employee component plus $17,500 as the employer component (25% of $70,000), for a total of $41,000. Under a SEP-IRA with the same salary, the maximum is $17,500 (25% of $70,000). The Solo 401(k) shelters $23,500 more. The plans converge only when compensation reaches $280,000, at which point the 25% employer contribution alone hits $70,000.

An additional advantage of the Solo 401(k) is the Roth option. Many Solo 401(k) providers allow Roth elective deferrals, where the $23,500 employee contribution goes in after-tax but grows and is withdrawn tax-free. SEP-IRAs are pretax only (the SECURE 2.0 Act technically authorized Roth SEP contributions, but custodian adoption has been slow).

The Solo 401(k) also permits participant loans (up to $50,000 or 50% of the vested balance, whichever is less), which can provide short-term liquidity without triggering a taxable distribution. SEP-IRAs do not allow loans.

How does S-Corp salary affect retirement contributions?

For franchise owners operating through an S-corp (and most should be, once net income consistently exceeds $60,000 to $80,000, as discussed in the franchise entity structure guide), the W-2 salary is the foundation for retirement plan contributions. Both the SEP-IRA and the Solo 401(k) employer contribution are capped at 25% of W-2 compensation, and the Solo 401(k) employee deferral requires W-2 compensation of at least the deferral amount.

This creates a direct tension with the FICA-saving strategy. Setting your S-corp salary at $50,000 to minimize self-employment tax caps your employer profit-sharing at $12,500 (25% of $50,000) and your total Solo 401(k) contribution at $36,000 ($23,500 deferral + $12,500 profit-sharing). Raising the salary to $100,000 increases your FICA cost by roughly $7,650 (the employee and employer shares combined on the additional $50,000) but raises the employer profit-sharing cap to $25,000, a $12,500 increase that generates $4,375 in tax savings at a 35% marginal rate, growing tax-deferred for years.

The optimal salary balances three factors: FICA savings (lower salary is better), retirement contribution capacity (higher salary is better), and the IRS’s reasonable compensation standard (too low and the IRS reclassifies distributions as wages). For most franchise owners, the answer is a salary that satisfies reasonable compensation and supports the desired retirement contribution level. A CPA should model both numbers together, not optimize one in isolation.

What plans work when you have employees?

Most franchise systems require employees. A restaurant franchise might have 15 to 40 crew members. A fitness franchise might have 8 to 12 trainers and front-desk staff. Once non-owner employees enter the picture, the Solo 401(k) is off the table, and the plan must include eligible employees under the coverage and nondiscrimination rules of IRC 410 and IRC 401(a)(4).

The SIMPLE IRA is the lowest-cost option for franchises with 100 or fewer employees. Employee elective deferrals are capped at $16,500 for 2025 ($20,000 if age 50+). The employer must either match employee contributions dollar-for-dollar up to 3% of compensation (reducible to 1% in two out of five years) or make a 2% nonelective contribution for all eligible employees regardless of whether they defer. Setup is a two-page form (IRS Form 5304-SIMPLE or 5305-SIMPLE), and there is no annual Form 5500 filing. The contribution limits are lower than a 401(k), which constrains high-income owners. But for a franchise owner earning $100,000 who wants simplicity, a $16,500 deferral plus a 3% employer match ($3,000) shelters $19,500, which is meaningful.

The Safe Harbor 401(k) is the plan of choice for franchise owners who want to maximize their own contributions while offering a plan to employees. The Safe Harbor design satisfies the IRC 401(k) nondiscrimination tests automatically, so the owner can defer the full $23,500 ($31,000 if 50+) without worrying that low employee participation will fail the ADP test and force a refund of the owner’s contribution. The employer must provide either a 3% nonelective contribution to all eligible employees or a matching contribution of 100% on the first 3% of compensation deferred plus 50% on the next 2% (the “basic match” formula). The employer contribution is the cost of the Safe Harbor, but for most franchise owners the trade-off is worth it: the owner’s $23,500 deferral plus 25% employer profit-sharing on their salary shelters far more than a SIMPLE IRA allows.

Administrative costs for a Safe Harbor 401(k) run $2,000 to $5,000 per year for a plan with 10 to 50 participants (third-party administrator fees, annual Form 5500 filing, participant notices, compliance testing). For a franchise generating $500,000+ in revenue, this is a rounding error relative to the tax savings.

The SEP-IRA remains an option for franchise employers, but it has a structural disadvantage: any employer contribution percentage applies equally to all eligible employees. If the owner contributes 25% of her salary, she must contribute 25% of every eligible employee’s compensation. For a restaurant franchise with $400,000 in total employee payroll, a 25% employer SEP contribution costs $100,000 in addition to the owner’s own contribution. This makes the SEP impractical for most franchise businesses with significant payroll. The Safe Harbor 401(k) is almost always more cost-effective because the employer obligation is 3% (nonelective) or roughly 4% (match), not 25%.

Can a defined benefit plan shelter $200,000+ yearly?

Yes, and for the right franchise owner, a defined benefit plan is the most powerful tax-reduction tool available. Defined benefit plans under IRC 414(j) promise a specific retirement benefit (a monthly pension), and the annual contribution is whatever the actuary determines is necessary to fund that promise. For older, high-income business owners, the required contribution can exceed $200,000 per year because the funding window to retirement is shorter.

The ideal candidate for a defined benefit plan is a multi-unit franchise operator over age 50, with consistent annual income of $300,000 or more, and a manageable employee headcount (because employee benefits must be provided on a nondiscriminatory basis). The plan can run alongside a 401(k) in a “combo plan” or “DB/DC” arrangement, where the owner contributes $23,500 to the 401(k) elective deferral and $200,000+ to the defined benefit plan, sheltering a combined $225,000 or more from current-year taxation.

The costs are higher than defined contribution plans. An actuary must design the plan and produce annual valuations ($2,000 to $5,000 per year). There is a Form 5500 filing and PBGC premium requirement. Employee benefits must be funded alongside the owner’s benefit. And the contribution commitment is ongoing: once the plan is established, the funding obligation is mandatory (underfunding triggers excise taxes). This is not a plan for a franchise owner with volatile income. It works best for operators with predictable, high cash flow across multiple units, a profile described in the multi-unit franchise tax planning guide.

What’s the SECURE 2.0 Starter 401(k)?

The SECURE 2.0 Act (enacted December 2022) created a new plan type called the Starter 401(k), available to employers that do not currently sponsor a retirement plan. The Starter 401(k) is designed as a low-friction entry point for small employers, including franchise operators with high-turnover workforces who have avoided offering a plan because of the administrative cost.

The Starter 401(k) allows employee elective deferrals only, with no employer contribution required. Contribution limits match IRA limits ($7,000 for 2025, $8,000 if age 50+), not the higher 401(k) limits. All employees who meet age and service requirements must be automatically enrolled at a default deferral rate between 3% and 15% of compensation.

For franchise owners, the Starter 401(k) is a middle ground. It provides a workplace retirement plan (which some states now mandate and which can help with employee retention in competitive franchise labor markets) without the employer contribution obligation of a Safe Harbor 401(k) or SIMPLE IRA. The trade-off is the low contribution limit: a franchise owner who wants to shelter significant income for herself will need a different plan for that purpose. The Starter 401(k) is an employee benefit, not an owner tax-planning tool.

That said, a franchise owner could pair a Starter 401(k) for employees with a separate defined benefit plan or cash balance plan for herself (subject to nondiscrimination testing across all plans of a single employer). The combination provides employee coverage at minimal employer cost and maximum owner tax shelter.

How do you choose between plans as your franchise grows?

The progression typically follows the business lifecycle. A franchise owner who starts as a sole operator, transitions to a small team, and eventually runs multiple locations will move through several plan types over the course of a career.

• Pre-opening / year one (no employees): Solo 401(k). Maximum flexibility, highest contribution capacity relative to income, Roth option, loan provision. Establish the plan before year-end of the first year you want to contribute.
• First employees hired (1-5 employees): If employees are part-time or seasonal (common in food service franchises), the Solo 401(k) may survive briefly under the eligibility rules (employees who work fewer than 1,000 hours per year or have less than one year of service can be excluded). But the window is narrow. Transition to a SIMPLE IRA (lowest cost) or Safe Harbor 401(k) (highest owner contribution capacity).
• Established single unit (5-30 employees): Safe Harbor 401(k) is the standard. The 3% nonelective contribution on employee pay is a known, budgetable cost. The owner maximizes deferrals and employer profit-sharing. Annual admin costs of $2,000 to $5,000 are reasonable at this scale.
• Multi-unit, high income ($300K+): Add a defined benefit or cash balance plan on top of the 401(k). The combined shelter can exceed $250,000 per year. Requires actuarial oversight but delivers proportional tax savings. The franchise exit strategy guide covers how these plans interact with the eventual sale of the franchise portfolio.

One rule applies at every stage: the plan must be established before December 31 of the year for which you want the first contribution to count (Solo 401(k), Safe Harbor 401(k), defined benefit). The SEP-IRA is the exception, since it can be established and funded up to the tax filing deadline including extensions. But waiting until tax time to decide on a plan limits your options to the SEP alone.

What about the tax credit for starting a new plan?

The IRC 45E small employer pension plan startup cost credit covers 100% of eligible startup costs (up to $5,000 per year for three years) for employers with 50 or fewer employees who did not maintain a retirement plan in the prior three years. SECURE 2.0 enhanced this credit and added an additional credit for employer contributions (up to $1,000 per employee for the first five years, phasing out for employers with 51 to 100 employees).

For a franchise owner establishing a Safe Harbor 401(k) with 20 employees, the startup credit alone can cover the entire third-party administrator cost for the first three years. The employer contribution credit offsets the Safe Harbor’s 3% nonelective contribution on up to $1,000 per employee per year. Combined, these credits can make the first few years of a 401(k) plan nearly cost-neutral for the employer, while the owner’s personal tax savings from contributions begin immediately. The credits are part of the general business credit on Form 3800, claimed on the employer’s income tax return. The payroll tax implications of running a plan alongside your franchise payroll obligations are covered in the franchise payroll tax guide.

What should you do next?

The right plan depends on where you are today: your income, your employee count, your entity structure, and your timeline to retirement. The contribution deadlines are real (December 31 for most plan types, April 15 or October 15 for SEP-IRA), and the cost of waiting one year is the lost tax-deferred compounding on that year’s contribution.

• Franchise entity structure: LLC, S-Corp, and multi-unit strategies, for how S-corp salary interacts with contribution limits
• Franchise cash flow and working capital tax planning, for coordinating retirement contributions with estimated tax payments and Section 179 purchases
• Multi-unit franchise tax planning and holding company structures, for how defined benefit plans fit into a multi-unit portfolio

Related guides:

• Franchise Bookkeeping Chart Of Accounts Royalties
• Franchise Cost Segregation Leasehold Improvements
• Franchise Employee Retention Payroll Tax
• Franchise Entity Structure Llc Scorp Multi Unit
• Franchise Exit Strategy Retirement Succession

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