As a sole proprietor, retirement contributions are calculated on net self-employment income, so all your profit counts toward the base. As an S corporation, employer contributions are 25% of your W-2 wages and distributions do not count at all — which means the low salary that minimises payroll tax also minimises how much you can put away. Both entities share the same 2026 caps: $24,500 of employee deferral and $72,000 all-in. The right salary balances the payroll-tax saving against the retirement room, and must still be reasonable for the work performed.
The number everything hangs on
Retirement contributions for the self-employed are not calculated on revenue, and not on profit as most people define it. They are calculated on a base that differs by entity, and that difference is the whole comparison.
| Sole proprietor / single-member LLC | S corporation | |
|---|---|---|
| The contribution base | Net earnings from self-employment, after the 92.35% adjustment and after half the self-employment tax | W-2 wages you pay yourself. Distributions do not count. |
| Employee deferral, 2026 | $24,500 ($32,000 at 50+; $35,750 at 60–63) | Same, but limited by your W-2 wages |
| Employer contribution | About 20% of net self-employment income | 25% of W-2 wages |
| Total cap, 2026 — IRC §415(c) | $72,000, plus catch-up | $72,000, plus catch-up |
| Payroll tax on the profit | Self-employment tax on all net earnings | Only on the W-2 wages; distributions escape it |
| Compensation cap, 2026 | $360,000 | $360,000 |
| Payroll administration | None required | Required — real payroll, real filings, real cost |
The 92.35% factor is IRC §1402(a)(12) and it is applied once, not twice — a mistake common enough that we built the calculator partly to stop making it. Run your own numbers →
The tension nobody explains at the incorporation stage
The reason people elect S-corp status is to pay themselves a reasonable salary and take the rest as distributions, which are not subject to self-employment tax. That saving is real.
But the same move shrinks the base your retirement contribution is calculated on. Employer contributions are 25% of W-2 wages, and your employee deferral cannot exceed your wages either. Drive the salary down to minimise payroll tax and you have also driven down how much you can put away — and unlike the payroll tax saving, that one compounds for thirty years.
These two objectives pull in opposite directions, and there is a salary level where the total is optimised. It is specific to your income, your plan design, your age and your bracket, and it is worth an afternoon with your CPA. The IRS also requires the salary to be reasonable for the work performed; a salary set purely to minimise tax is an audit exposure, not a strategy.
A worked comparison
Take $150,000 of business profit, one owner, no employees, a solo 401(k), age 45.
- As a sole proprietor: the deferral of $24,500 plus roughly 20% of net self-employment income. The base is large because all the profit counts, so the total contribution lands high — but self-employment tax applies to all of it.
- As an S corporation paying a $60,000 salary: the $24,500 deferral still fits, and the employer piece is 25% of $60,000 = $15,000. Payroll tax is saved on the $90,000 taken as distributions — but the employer contribution is smaller than the sole proprietor’s.
- As an S corporation paying a $110,000 salary: the employer piece rises to $27,500, and the payroll tax saving shrinks.
Which wins depends on your marginal bracket, whether you would actually contribute the maximum, and what payroll administration costs you. Anyone who answers this question without asking those three things is guessing. The calculator does the arithmetic for each case →
Which plan, by situation
- Solo 401(k) — owner and spouse only, no other employees. Almost always the highest contribution at a given income, because it has both an employee deferral and an employer piece. A Roth option is usually available.
- SEP IRA — employer contribution only, no deferral. Simple, opened late in the year, but it needs far more income to reach the same total, and it complicates a backdoor Roth through the pro-rata rule.
- SIMPLE IRA — $17,000 deferral in 2026 plus a required employer contribution. Cheap to run once you have employees; lower ceiling.
- Defined benefit or cash balance plan — for high, stable profit and an older owner, contributions can far exceed $72,000. It carries actuarial cost and a funding obligation.
The four plans compared in full → · Written for business owners →
Common questions
Does an S corporation let me save more for retirement?
Usually the opposite, at a given profit level. Employer contributions are 25% of W-2 wages, so a low salary means a low ceiling. What the S election saves is payroll tax, not retirement room, and the two objectives conflict.
What is a reasonable salary for an S-corp owner?
The IRS standard is reasonable compensation for the services performed, judged against what comparable work pays. There is no safe-harbour percentage despite what you will read. This is a question for your CPA, and the answer should be documented.
Can I have a solo 401(k) and a job with a 401(k)?
Yes. The employee deferral limit — $24,500 in 2026 — is yours across all plans combined, but the employer contribution from your business is separate and sits under its own §415(c) limit for that plan.
When do I have to set the plan up?
Deadlines differ by plan type and have changed under SECURE 2.0, with some plans now able to be adopted after year end. Confirm the current deadline for your plan type and tax year with your CPA before relying on it.
Get the salary and the plan decided together
They are one decision, and most people make them a year apart. Fifteen minutes, free, and we will happily talk to your CPA.