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S-corp owners don’t get to “set and forget” retirement planning the way many W-2 employees do. The reason is simple: your retirement plan contributions usually hinge on compensation, and for an S-corp owner that typically means W-2 wages, not the owner distributions you take from profits. The right plan can create major tax advantages, but the wrong setup (or the right plan with the wrong payroll treatment) can quietly cap your contributions and create compliance headaches.
This guide will help you make a practical decision between a SIMPLE IRA and a 401(k) (either a Solo/one-participant 401(k) if you qualify, or a traditional 401(k) if you have employees). We’ll focus on the issues that actually swing the decision for S-corp owners: how you pay yourself, whether you have employees (now or soon), how much you want to contribute in strong vs. lean years, and what you’re willing to take on in administration and cost.
How S-Corp Pay Impacts Retirement Plan Contributions
Why W-2 Wages Matter More Than Owner Distributions
For retirement plan purposes, S-corp distributions are not considered compensation the way payroll wages are. If you’re a shareholder-employee, your retirement contributions are generally driven by compensation from the business, not by the distributions you take. In other words, the plan calculations typically look to what you were paid as wages (W-2), not what you pulled out as distributions.
That one distinction is why two S-corp owners with the same business profit can end up with totally different retirement outcomes. If one owner runs a clean payroll with reasonable W-2 wages, they often have more room to contribute (depending on the plan design). If the other keeps wages artificially low and takes the rest as distributions, they can unintentionally choke off their ability to fund a plan—even though the business is making plenty of money.
What “Compensation” Usually Means for Plan Calculations
“Compensation” is one of those words that sounds obvious until you’re trying to fund a retirement plan. The key point: your plan document defines compensation, and that definition controls how contributions are calculated. The IRS also publishes annual caps and limits that affect how much compensation can be counted for plan purposes (for 2025, the annual compensation cap used for certain plan calculations is $350,000).
In real-world payroll terms for an S-corp owner-employee, you should expect most plan math to start from your W-2 wages, then apply the plan rules. If you ever find yourself saying, “But I took $X out of the business, so I should be able to contribute based on $X,” pause right there. That assumption is one of the most common ways S-corp owners end up underfunding—or misfunding—their retirement plan.
The Big Mistake S-Corp Owners Make With “Low Salary”
Many S-corp owners have heard the strategy: “Keep your salary low, take the rest as distributions.” The problem is that salary can’t be “whatever you feel like.” The IRS expects shareholder-employees who perform services for the corporation to receive reasonable compensation. If wages are unreasonably low, you’re not just limiting retirement plan contributions—you’re also increasing audit risk, because the IRS can reclassify payments and assess payroll tax and penalties.
Even when you’re trying to be conservative, the retirement-plan side effect is immediate: low W-2 wages often mean lower possible contributions (especially on the employer side of a 401(k)). So the “low salary” approach can backfire twice: it can invite compliance scrutiny and also make it harder to use retirement plans as a tax strategy.
SIMPLE IRA Basics for S-Corp Owners
Who SIMPLE IRAs Are Best For (And When They’re Not)
A SIMPLE IRA is designed for smaller employers that want an easier retirement plan. Generally, it’s aimed at businesses with 100 or fewer employees who earned at least a minimum amount in prior years, and the employer generally cannot maintain another retirement plan in the same year.
SIMPLE IRAs tend to fit best when you want:
- A plan that’s relatively straightforward to operate year after year
- Predictable employer funding rules (clear match/nonelective formulas)
- Less administrative complexity than a traditional 401(k)
Where SIMPLE IRAs are usually a poor fit is when you want maximum flexibility and maximum contribution potential, or when you want features SIMPLE IRAs don’t offer (for example, SIMPLE IRAs don’t allow designated Roth contributions).
Required Employer Contributions and How They Work
Unlike a profit-sharing contribution that you can choose to make (or skip), a SIMPLE IRA comes with required employer funding. The employer generally must choose one of two approaches each year:
- Matching contribution: Usually a dollar-for-dollar match on employee salary reduction contributions up to 3% of compensation (with rules allowing a reduction to as low as 1% in no more than two out of five years).
- 2% nonelective contribution: A contribution of 2% of compensation for each eligible employee, even if the employee doesn’t contribute.
Two practical implications matter for S-corp owners. First, employer funding affects cash flow: if you have eligible employees, your required employer money may be meaningful. Second, SIMPLE IRA contributions are always 100% vested—there’s no vesting schedule to encourage retention the way some 401(k) plans can use for employer contributions.
SIMPLE IRA Contribution Limits and Timing (High-Level)
For 2025, the standard employee salary reduction (deferral) limit for SIMPLE plans is $16,500, with a catch-up contribution of $3,500 for those age 50+, and a higher catch-up limit of $5,250 for ages 60–63. (There are also “applicable” SIMPLE arrangements that can allow higher limits in some cases.)
Timing matters with SIMPLE IRAs more than people think. A SIMPLE IRA generally must be established by October 1 for an existing business (with exceptions for new employers), and employees must be given a notice and a chance to make or change salary reduction elections during the required election period. Also, salary reduction contributions must be deposited timely—generally as soon as reasonably possible, and no later than 30 days after the end of the month in which the amounts would otherwise have been payable in cash.
401(k) Options for S-Corp Owners (Solo or Traditional)
Solo 401(k) vs. Traditional 401(k) (When Each Applies)
A Solo 401(k) (also called a one-participant 401(k)) is available only when the only eligible participants are the owner (or owners) and possibly their spouses—no common-law employees who meet eligibility requirements. Once you have eligible employees, you’re no longer in Solo 401(k) territory and need a plan designed for a workforce (often a traditional 401(k), sometimes with safe harbor features).
This is why “future hiring plans” matter. If you plan to add staff soon, starting with a Solo 401(k) can be great for simplicity today, but you should choose providers and plan designs that won’t turn into a mess when you outgrow the solo setup.
Employee Deferrals vs. Employer Contributions (The Two-Bucket Concept)
A 401(k) is powerful because it has two main contribution “buckets”:
- Bucket 1: Employee elective deferrals. For 2025, elective deferrals are capped at $23,500, with a catch-up of $7,500 for age 50+, and a higher catch-up of $11,250 for ages 60–63.
- Bucket 2: Employer contributions. In a one-participant 401(k), employer contributions are typically up to 25% of compensation (as defined by the plan) for corporate participants, subject to overall limits. The overall defined contribution limit for 2025 is $70,000 (not counting catch-up contributions).
For S-corp owners, the “compensation” your employer percentage is based on is generally tied to W-2 wages—not distributions—so payroll strategy and plan strategy have to line up.
Roth 401(k) Feature and When It Can Make Sense
A Roth 401(k) (more precisely, a designated Roth account inside the 401(k)) allows you to make elective deferrals that are included in your taxable income now, but qualified distributions can be tax-free later if the rules are met. This can make sense when you believe your tax rate is likely to be higher in retirement, or when you want tax diversification so you’re not “all-in” on pre-tax savings.
Two important clarifications: Roth vs. traditional doesn’t increase the contribution limit—it’s mostly a tax-timing choice—and it’s only available if your plan document includes the Roth feature. Also, this is a key difference from a SIMPLE IRA: SIMPLE IRAs do not allow designated Roth contributions.
SIMPLE IRA vs. 401(k) for an S-Corp: Decision Factors That Actually Matter
Headcount and Eligibility Rules (Employees Change Everything)
If you have eligible employees, the decision stops being theoretical. SIMPLE IRA rules can work well for a small team, but they require employer contributions and generally can’t coexist with another plan in the same year. A 401(k) can offer more design flexibility, but that flexibility comes with more administration and, in many cases, nondiscrimination testing unless you adopt safe harbor-type designs.
If you have no employees (other than a spouse) and don’t expect to hire soon, the Solo 401(k) is often the cleanest “high ceiling, low headcount” option.
Cost, Complexity, and Administrative Responsibilities
A SIMPLE IRA is typically lighter operationally: fewer moving parts, no annual nondiscrimination testing like a traditional 401(k), and it’s structured around straightforward contributions and notices.
A 401(k), on the other hand, can involve a plan document, payroll coordination, potential testing, and ongoing administration. Even Solo 401(k)s can trigger filing requirements once plan assets reach certain thresholds (for example, Form 5500-EZ filing is commonly required once the plan exceeds $250,000 in assets at year-end).
How Much You Want to Contribute Each Year (Low vs. High Income Years)
If you’re aiming for modest contributions and want predictability, SIMPLE IRAs can be a good match because the limits are lower and the employer funding formula is defined. For 2025, the employee deferral limit is $16,500 in a SIMPLE plan compared with $23,500 in a 401(k).
If you want the ability to push contributions higher in strong years—especially using the employer “bucket” in addition to employee deferrals—a 401(k) (often Solo 401(k) for owner-only) usually leaves more room, subject to the annual overall limit of $70,000 for 2025.
Matching Requirements and Cash-Flow Predictability
SIMPLE IRA employer contributions are not “maybe.” You must make either the match or the nonelective contribution each year you maintain the plan, which makes budgeting more predictable but also more rigid.
401(k) plans can be structured in different ways. Some designs are very predictable (safe harbor contributions), while others give the employer more discretion (profit-sharing style contributions). The “best” choice is often the one that matches how stable your cash flow truly is, not how stable you hope it will be.
Coordination With Other Retirement Accounts (If You Have Them)
If you also have a day job with a 401(k), or a spouse has access to an employer plan, you need to pay attention to how annual limits interact. Elective deferrals are subject to overall limits across plans, and SIMPLE IRA salary reductions can be affected if you’re contributing in multiple employer plans in the same year.
This is also where clean recordkeeping matters. Retirement plans are compliance-heavy by nature, and small “oops” errors can create disproportionate cleanup work. If you’re already paying for tax and accounting services, coordinating plan contributions with payroll and entity reporting is one of the highest-value places to use that support.
A Practical “Choose This If…” Checklist + Next Steps
Choose a SIMPLE IRA If…
A SIMPLE IRA is often the right call if most of these are true:
- You have employees (or expect to), and you want a plan that’s relatively easy to explain and maintain year after year.
- You’re comfortable with required employer contributions (match or 2% nonelective), and you like the predictability that comes with that structure.
- You don’t need a Roth feature inside the plan, and you’re fine with SIMPLE contribution limits being lower than a 401(k).
Choose a 401(k) If…
A 401(k) is often the better fit if most of these are true:
- You have no eligible employees (other than a spouse) and want a high-contribution option with relatively clean mechanics (Solo/one-participant 401(k)).
- You want the flexibility of employee deferrals plus employer contributions, aiming toward the higher annual maximums (within IRS limits).
- You want the option for Roth 401(k) deferrals for tax diversification.
Implementation Steps and What to Review With Your CPA/Plan Provider
No matter which plan you choose, the setup quality is what determines whether the strategy actually works. Here’s what you should review before you sign anything:
- Confirm your eligibility (especially employee status and expected hiring). A Solo 401(k) is only “solo” if you truly have no eligible employees.
- Align payroll with the plan design. For S-corp owners, contributions generally track W-2 compensation, not distributions, so your wage strategy affects your retirement ceiling.
- Map the year’s deadlines. SIMPLE IRAs have establishment and deposit timing rules that are easy to miss, and 401(k) deferrals require proper election timing through payroll.
- Run a “good year vs. lean year” projection. Compare what you could contribute under each plan when profits are high and when cash flow is tight, using the current IRS limits as guardrails.
- Ask about credits and deductions. Depending on your situation, there may be tax incentives for starting a plan and clear deduction rules for employer contributions.
If you want help choosing and implementing the right plan for your S-corp—without guessing your way through payroll, contributions, and compliance—Small Business Taxes LLC can help. Reach out to discuss your retirement plan setup, S-corp compensation, and the next best step for your business.
