3 Steps to Set Up Retirement Contributions

Key Takeaways

• A Solo 401(k) can shelter up to $70,000 from federal and California state taxes in 2026.
• A SEP-IRA can cover up to 25% of your net self-employment income.
• There are three steps to making this work: choosing the right plan, setting a contribution target based on your actual income, and funding it throughout the year.
• The Solo 401(k) plan itself must be established by December 31 of the tax year you want to use it. Missing that date means waiting another year.
• For California business owners paying up to 13.3% in state income tax on top of federal rates, these contributions reduce taxable income at both levels simultaneously.

If you've ever gotten to tax time and heard "you could have reduced this significantly with retirement contributions" - you're not alone. It's one of the most common things we see. The deduction is real, it's substantial, and it's legal. The part that goes wrong is the timing and setup, not the concept.

Here's how to do it right.

Step 1: Choose the Right Plan

Two plans come up most often for California small business owners: the Solo 401(k) and the SEP-IRA. They're not interchangeable.

Solo 401(k)

This plan is designed for owner-only businesses, though a spouse can participate too. The contribution limit is higher than most owners expect because you contribute in two roles at once — as the employee and as the employer.

In 2026, you can contribute up to $23,500 as the employee (this is called an elective deferral), plus up to 25% of your compensation as the employer. Combined, the ceiling is $70,000. If you're between 60 and 63, an enhanced catch-up provision pushes that to $81,250.

One important detail: the plan must be established by December 31 of the tax year you want to use it for. You can fund it after that date, up to your tax filing deadline — but the plan has to exist first.

SEP-IRA

The SEP-IRA (Simplified Employee Pension) is simpler to set up and has almost no ongoing administration. You contribute only as the employer — up to 25% of your net self-employment income, with the same $70,000 ceiling.

The tradeoff: because there's no employee deferral component, the SEP-IRA reaches its ceiling based purely on your profit percentage. At lower income levels, that ceiling arrives faster than most owners realize.

For example, if your net self-employment income is $80,000 in 2026, a SEP-IRA limits you to around $14,800. A Solo 401(k) would let you contribute up to $23,500 in employee deferrals alone — before the employer contribution is added.

One advantage: a SEP-IRA can be opened and funded as late as your tax filing deadline, including extensions. That means as late as October of the following year if you file an extension.

If you have employees, the SEP-IRA requires you to contribute the same percentage for eligible employees as you do for yourself. That changes the math significantly. A Solo 401(k) is only for owner-only businesses. If you have staff, a different plan structure is likely the right answer — that's a conversation worth having with your accountant before you set anything up.

Step 2: Set a Contribution Target

There are two ways owners approach this, and both can work depending on how you run your business.

The proactive approach is setting a target at the start of the year based on projected income.

If you have a reasonable sense of what profit will look like, your accountant can estimate your tax exposure for the year and work backward to a contribution number that makes sense.

This is more plan focused and the approach we take with our clients.

This works well for owners with relatively predictable revenue.

The reactive approach is getting to Q3, looking at what you are ending the year with, and deciding what you have left to put away. Less precise, but still useful.

If you have the discipline to actually set it aside when Q3 arrives, it works. If not, you end up at December with less than you intended to contribute.

Neither approach is wrong. The proactive one tends to result in larger contributions because the decision gets made before the money disappears into operations.

Step 3: Time Your Contributions to Your Cash Flow

Knowing your target is one thing. Moving the money is another.

The owners who consistently fund their plans are the ones who tie contributions to a rhythm that already exists in the business, not a separate decision they have to make from scratch every month. Quarterly estimated tax payment dates work well for this. When you're calculating what you owe the IRS and the FTB, that's a natural moment to fund the retirement account at the same time.

For businesses with more predictable monthly cash flow, a recurring transfer removes the decision entirely. For businesses with uneven income - project-based work, seasonal revenue - contributing after a strong month or a large client payment tends to be more realistic than a fixed schedule.

The goal is to avoid arriving in December with a contribution target you haven't touched. At that point the money has to move in one transaction, and it's competing with every other year-end expense.

A Closer Look: Maria's 2026 Contribution

Maria runs a marketing agency in Irvine as a sole proprietor. In early 2026, she sets up a Solo 401(k) — the plan is established in January, which satisfies the December 31 requirement for the 2026 tax year.

Her projected net self-employment income for the year is $140,000.

Working with her accountant, she sets a contribution target of $40,000: $23,500 in employee deferrals and $16,500 as the employer contribution (roughly 25% of her adjusted net earnings after the self employment tax deduction).

She sets up a $3,300 monthly transfer into the account. By December, the account is fully funded with no single large outflow.

At tax time, that $40,000 reduces her federal taxable income and her California taxable income while keeping the money with her as a business owner.

The tax reduction comes to roughly $18,000. The contribution cost her $40,000 in cash, but $18,000 of that came back in taxes she didn't pay.

What's Different for California Business Owners

California conforms to federal rules on retirement plan deductions, contributions to a Solo 401(k) or SEP-IRA reduce your taxable income for California purposes the same way they do federally. That matters because California's tax rate of 13.3% applies to ordinary business income with no distinction for how long you've held anything.

There's no California-specific retirement deduction beyond what the federal rules allow, but the state's high rate means the federal deduction is worth more here than it would be in most other states.

One thing to be aware of: California does not conform to federal rules on Roth 401(k) treatment in all cases.

If you're considering a Roth component inside your Solo 401(k), talk to your accountant about how California will treat those contributions and future distributions before you make elections.

Why This Matters

The retirement contribution deduction isn't complicated once the structure is in place. What makes it hard is that it requires decisions before the year is over, ideally well before.

Owners who plan, set a target, and make the decision to follow through on the deduction in the same year are able to claim the deduction and get the full benefit. Owners who do two out of the three, or who get to it in January, don't.

If you're not sure which plan fits your situation, or you want to run the numbers on what a contribution target should look like for your 2026 income, that's exactly the kind of conversation we have with clients.

Book a free initial consult with N&CO here.

Frequently Asked Questions

Can I set up a Solo 401(k) if I have part-time employees? Only if those employees do not meet the plan’s eligibility rules. A Solo 401(k) is generally for a business owner with no common-law employees, or the owner and spouse only. Part-time employees who work under the plan’s eligibility threshold (500 hours in California) can usually be excluded, but long-term part-time employees may have to be included once they meet the federal service requirements

What's the deadline to contribute to a SEP-IRA for 2026? You can open and fund a SEP-IRA up to your tax filing deadline, including extensions. If you file an extension, that's October 15, 2027 for the 2026 tax year. The Solo 401(k) is different — the plan must be established by December 31, 2026, even if you fund it later.

Do retirement contributions reduce my self-employment tax? Not directly. Self-employment tax is calculated on your net self-employment income before retirement deductions. However, you do get to deduct half of your self-employment tax before calculating your contribution limits and your income tax — so the retirement deduction still reduces your income tax at both the federal and California state level.

What if my income varies a lot year to year? That's actually an argument for the Solo 401(k) over the SEP-IRA. The employee deferral component of the Solo 401(k) is a fixed dollar amount (up to $23,500) that doesn't depend on your profit percentage. In a lower income year, you can still contribute a meaningful amount. In a higher income year, you add the employer contribution on top.

Can my spouse contribute too? If your spouse works in the business and receives compensation, they can participate in the Solo 401(k) with their own contribution limits — effectively doubling the household's sheltered amount. This is one of the more underused features of the plan.