SEP-IRA vs Defined Benefit Plan 2026

A physician, dentist, attorney or consultant earning $400,000 or more from a practice has two retirement plan tools that go far beyond an ordinary IRA: the SEP-IRA and the defined benefit (cash balance) plan. Used correctly, together with a 401(k), they can move well over $200,000 a year out of the top tax bracket. This article lays out the 2026 contribution limits, explains why a SEP and a defined benefit plan usually should not be run side by side, and shows the combination that high earners actually use.

SEP-IRA: simple, flexible, but capped

A SEP-IRA is funded entirely by the employer. For 2026 the contribution for each participant is limited to the lesser of 25% of compensation or $72,000, using a compensation cap of $360,000. For a sole proprietor the 25% is applied to net earnings after the deduction for half of self-employment tax and after the contribution itself, which works out to about 20% of net profit.

Its strengths are real: no annual Form 5500, a plan can be opened and funded as late as the extended due date of the return, and the contribution percentage can change every year, including to zero. Its weaknesses are just as real. Whatever percentage the owner takes, every eligible employee must receive the same percentage, and there are no employee deferrals, no Roth option in most custodial documents, and no loans. Once a practice has staff, the SEP becomes an expensive way for the owner to save.

Defined benefit plan: the large deduction

A defined benefit plan promises a retirement benefit, currently capped at an annual pension of $290,000 for 2026, and the employer must contribute whatever an actuary calculates is needed to fund that promise. Because the target is a benefit rather than a contribution, the annual deduction depends on age and income. A 55-year-old earning $360,000 can typically deduct $200,000 to $300,000 per year; a 40-year-old with the same income is usually in the $100,000 to $150,000 range.

The modern form is the cash balance plan, which states each participant's benefit as an account balance with a guaranteed credit rate, making it easier to explain to employees and simpler to terminate. The costs are an actuarial valuation each year, Form 5500 and PBGC filings where applicable, and a required contribution: unlike a SEP, you cannot skip a year without an amendment. Plans are expected to be permanent, generally meaning three to five years minimum.

Why SEP plus defined benefit is usually the wrong pairing

The original idea of layering a SEP on top of a defined benefit plan runs into two rules. First, the IRS model SEP document (Form 5305-SEP) cannot be used at all by an employer that maintains any other qualified plan. Second, under §404(a)(7), when an employer has both a defined benefit plan and a defined contribution plan not covered by PBGC insurance, employer contributions to the defined contribution plan are limited to 6% of compensation if the defined benefit contribution exceeds 6% of pay. A 25% SEP contribution simply is not deductible in that situation.

The combination that works: 401(k) plus cash balance

High earners pair the defined benefit plan with a 401(k) profit-sharing plan instead of a SEP. The 401(k) side contributes what a SEP cannot:

• Employee deferrals of $24,500 in 2026, which are not subject to the 6% limit; participants age 50 and older add an $8,000 catch-up, and those aged 60 to 63 may add $11,250.
• A 6% employer profit-sharing contribution, the maximum allowed alongside the defined benefit plan: $21,600 at the $360,000 compensation cap.
• The defined benefit contribution on top, often $150,000 to $300,000 depending on age.

For a 55-year-old owner with $360,000 of compensation, that stack is roughly $24,500 + $8,000 + $21,600 + $250,000, about $304,000 of deductible contributions in a single year, which at combined federal and California rates can save more than $140,000 in tax.

One 2026 change to note: participants whose prior-year FICA wages exceeded $150,000 must make catch-up contributions on a Roth basis. The deferral still goes in, but the catch-up portion is after-tax.

Employees change the arithmetic

Every qualified plan must pass nondiscrimination testing. In a practice with a 50-year-old owner and four staff in their thirties, a properly designed cash balance plan will typically require contributions of 5% to 8% of pay for the staff to support the owner's large contribution. That cost is deductible and often replaces raises the practice would give anyway, but it must be modeled before adopting the plan. Practices with many long-tenured older employees are the hardest to design for; practices where the owner is the oldest participant are the easiest.

Deadlines and mechanics

• A new 401(k) with deferrals must exist before year-end for the owner to defer for that year; the profit-sharing and defined benefit contributions can be funded up to the extended return due date.
• Under the SECURE Act rules an employer may still adopt a new defined benefit plan after year-end, up to the return due date, and fund it for the prior year.
• Contributions for a sole proprietor or partner are based on net self-employment earnings; for an S corporation owner they are based on W-2 wages only, which makes the S corporation salary decision inseparable from the retirement plan design.

When a SEP is still the right answer

A solo consultant with no employees, variable income and no interest in administration is often best served by a SEP or a solo 401(k). The defined benefit plan earns its cost when income is high and stable, the owner is over 45, and the goal is to shelter well above $72,000 per year for several years in a row.

Summary

The SEP-IRA and the defined benefit plan solve different problems. Use a SEP or solo 401(k) for simplicity and flexibility; use a cash balance plan paired with a 401(k) when the deduction needs to be measured in hundreds of thousands. The pairing to avoid is a full SEP on top of a defined benefit plan. A feasibility study from an actuary, done before the end of the year, tells you which structure fits your practice.

OKLEM CPA Group · Los Angeles Korean-speaking CPA Shin S. Oh · (213) 788-3388 · Individual and business tax, bookkeeping, payroll