Solo 401(k): Understanding self-employed retirement plans

Solo 401(k): Understanding self-employed retirement plans

01.17.2024

When you’re self-employed, you don’t have an employer helping you save for retirement through a company-sponsored plan or matching contributions. But it’s still just as important — if not more important — to prioritize retirement planning.

If you’re self-employed, you have several options you can adopt to help you save for retirement, both as an individual and a business owner. One of the most popular options is the solo 401(k), thanks to its high contribution limits and tax advantages.

What is a solo 401(k) plan?

A solo 401(k), also known as a one-participant 401(k) plan1, is for a company with no employees. A solo 401(k) shares all the characteristics of any other 401(k) plan, but it only covers the business owner and their spouse.

Solo 401(k) eligibility criteria

To open and contribute to a solo 401(k), you’ll have to meet two criteria:

  • You have self-employment income
  • Your business has no employees other than you and your spouse

Solo 401(k) contribution limits

A solo 401(k) is unique because the business owner and the employee are the same person. So, while they technically have the same contribution limits as other 401(k) plans, a self-employed individual has the opportunity to save more than a traditional employee would.

When discussing the solo 401(k) contribution limits, it’s important to break down the three categories of contributions: total contributions, elective deferrals, and employer nonelective contributions.

In 2024, the maximum amount that can be contributed to an individual’s 401(k) account is $69,000, up from $66,000 in 2023.2 Here’s how those contributions break down:

  • Elective deferrals: As an employee, a self-employed individual can contribute the lesser of 100% of their earned income or the maximum contribution limit which, in 2024, is $23,000, up from $22,500 in 2023.
  • Employer nonelective contributions: As a business owner, you may also make employer contributions to your solo 401(k) plan. Your business can contribute up to 25% of your compensation. Your compensation is considered your net earnings minus one-half of your self-employment tax and your employee elective deferrals. The maximum compensation for the purpose of employer nonelective contributions is $345,000 in 2024.

Finally, if you’re 50 or older, you’re also eligible for a catch-up contribution of $7,500, bringing your total allowed contributions to $30,500 in elective deferrals and $76,500 overall.

Read more: What is the 401(k) contribution deadline?

Solo 401(k) taxes

Solo 401(k) plans have the same tax benefits as the 401(k) plans offered by larger companies.

The most common type of 401(k) is the traditional 401(k). It’s a pre-tax account, meaning your contributions aren’t subject to income taxes. They reduce your taxable income for the current year and, therefore, your tax liability.

Let’s say you have a taxable income of $100,000. However, you contribute the maximum amount — $23,000 in 2024 — to your 401(k). Because you’ve made pre-tax 401(k) contributions, your taxable income is reduced to $77,000.

Once you contribute to your traditional 401(k) plan, you can invest the money and watch your money grow tax-free. It’s not until you start taking distributions that you’ll pay income taxes.

You can also opt for Roth contributions in a solo 401(k). A Roth 401(k) is one where you make after-tax contributions, meaning there’s no upfront tax benefit. However, you’ll then have the benefit of tax-free investment growth and tax-free qualified distributions.

Solo 401(k) distributions

Just as solo 401(k) plans have the same tax benefits as other 401(k)s, they also have the same distribution rules. Generally speaking, you shouldn’t withdraw from your 401(k) plan until you reach age 59 ½. Any withdrawals earlier than that are subject to a 10% additional tax, and that’s on top of the ordinary income taxes you’ll already pay on those distributions.

However, there are a few other exceptions that allow you to access your money early without the 10% additional tax (though ordinary income taxes will still apply):

  • You become totally and permanently disabled
  • You’re the beneficiary on a 401(k) plan where the participant has passed away
  • You pay for qualified birth or adoption expenses (up to $5,000)
  • You sustain an economic loss due to a federally declared disaster (up to $22,000)
  • You’re the victim of domestic abuse (up to $10,000)
  • You must pay under a Qualified Domestic Relations Order
  • You experience a personal or financial emergency (up to $1,000 once per year)
  • You take a series of substantially equal payments
  • Your plan is subject to an IRS levy
  • You pay for unreimbursed medical expenses of more than 7.5% of your AGI
  • You’re a qualified military reservist called to active duty
  • You leave your job during or after the year you turn 55
  • You’re terminally ill, as certified by a physician

Read more: IRS audit triggers

Benefits of a solo 401(k)

Solo 401(k) plans have some key benefits that make them a popular choice among self-employed individuals.

Simulating employer-sponsored retirement plans

If you’re self-employed, you don’t necessarily have access to the company-sponsored retirement plans many people use. However, a solo 401(k) offers nearly all the same benefits as one offered by a larger company.

Tax advantages and deductions

A solo 401(k) comes with considerable tax benefits, regardless of whether you choose a traditional or Roth 401(k). A traditional 401(k) offers an upfront tax benefit, while a Roth 401(k) offers a tax benefit during retirement.

For most people, there are no wrong answers when choosing between the two. After all, either tax benefit is better than no tax benefit at all. However, certain people may find that one or the other is best suited for them.

For example, someone with a high income and tax rate might prefer the traditional 401(k) since it allows them to reduce their tax liability right away. On the other hand, someone with a relatively low income or tax rate now might prefer to defer the tax benefit until retirement, when they might be in a higher tax bracket.

If you aren’t sure which tax benefit is better for you, consider consulting a tax professional who can look at your unique situation and make a recommendation.

High contribution limits for retirement savings

A key benefit of 401(k) plans is their high contribution limits. 401(k) plans have higher contribution limits than individual retirement accounts (IRAs), which only allow for contributions up to $7,000 per year. They also offer higher contribution limits than certain other self-employed retirement plans, such as SIMPLE IRAs, which allow contributions up to $16,000.

Catch-up contributions for those over 50

If you’re 50 or older, a solo 401(k) can help you save an impressive $76,500 per year for retirement, thanks to catch-up contributions. If you’re nearing retirement, this catch-up contribution can be an excellent opportunity to push you over the finish line of your retirement savings goals.

Flexibility and control over investments

When you contribute to a company-sponsored 401(k) plan, you’re limited to choosing from the small menu of investments the company chooses. But when you have a solo 401(k), you can choose your plan provider, as well as what to invest in. You have more control, not only over your investment options but also over your fees.

Ability to cover both the business owner and their spouse

A key benefit of a solo 401(k) that doesn’t exist with other retirement plans is that it can cover both you and your spouse. In fact, your spouse is the only other person that can be covered by your solo 401(k).

When you include your spouse in your solo 401(k), you essentially double the amount you can contribute as a couple. You both have a separate $69,000 total contribution limit, which can be made up of a combination of elective deferrals and employer nonelective contributions.

Keep in mind that for your spouse to be covered by your solo 401(k), they must be employed by and have income from your business. Additionally, the employer contributions you can make on their behalf are limited to 25% of their income.

How to open a solo 401(k) plan

Setting up a solo 401(k) is easier than you might think. Many online brokers offer solo 401(k) plans, meaning you can easily set one up yourself. Here are the steps you’ll need to follow to set up your solo 401(k):

  1. Get an employer identification number (EIN): You’ll need an EIN to open a solo 401(k), so if you don’t already have one, that should be your first course of action. You can apply for an EIN directly on the IRS website.
  2. Choose a broker: You can open a solo 401(k) with just about any major online broker. Top brokers like Vanguard, Charles Schwab, and Fidelity all offer solo 401(k) plans but so do many smaller online brokers.
  3. Complete a plan adoption agreement: When you start the process of opening your solo 401(k), your broker will provide you with an adoption agreement, which you’ll have to complete, sign, and return to your broker.
  4. Open your account: After you’ve completed your adoption agreement, you’ll complete an account application. On this form, you’ll provide personal information about yourself, as well as information about your business.
  5. Contribute to your account: Once your solo 401(k) is set up, you can set up your investments. You can make manual investments or set up automatic recurring investments to ensure consistency. You can also contribute on behalf of your business.
  6. Choose your investments: You can invest your solo 401(k) in nearly a wide variety of investments, including individual stocks and bonds, mutual funds, exchange-traded funds, and more.

Investment options and diversification

When you contribute to an employer-sponsored retirement plan through a company, you’re typically given a limited menu of investments to choose from. This menu usually includes mutual funds and ETFs, but there may only be a limited menu, many of which are target-date funds.

When you open a solo 401(k), you have complete control of your investments. By choosing an online broker for your 401(k), you have access to all of the securities that the broker offers.

While it’s a major benefit to be able to choose your own investments, it’s also a big decision. When selecting investments in your solo 401(k), it’s important to build a diversified portfolio designed to help you reach your retirement goals while mitigating your risk.

Special considerations for side-gig workers

If you have a job with a company that offers a 401(k) plan and also earn self-employment income, you can still open a solo 401(k). You can contribute to both that and your employer-sponsored 401(k) but with an important caveat.

The 401(k) contribution limits apply per person, not per plan. That means that, you as an individual, can contribute $23,000 to 401(k) plans in 2024. That could look like:

  • Contributing $23,000 to your employer’s 401(k) and $0 to your solo 401(k)
  • Contributing $0 to your employer’s 401(k) and $23,000 to your solo 401(k)
  • Contributing some money to your employer’s 401(k) and some to your solo 401(k)

There’s no right way to allocate your 401(k) contributions across multiple plans. If your employer offers a matching contribution, it’s almost certainly worth contributing at least enough to that plan to earn that extra contribution. However, you might prefer to contribute any additional money to your solo 401(k) since you have more control over your investments and fees.

Ongoing compliance

Solo 401(k) plans don’t require as much ongoing administration and compliance as traditional company plans, but there is some required. If your solo 401(k) has more than $250,000 in assets at the end of the year, you’ll be required to file an annual report on Form 5500-EZ. For assets less than $250,000, no annual report is required.

Seeking professional assistance

If the idea of opening and managing a solo 401(k) sounds overwhelming, but you want to start saving for retirement, you don’t have to do it alone. There are plenty of resources available to help make your investing journey easier. Here are a few things to consider:

  1. Hire a local financial advisor: A financial professional can help you set up your solo 401(k) and manage your investments on your behalf.
  2. Use an online service: An online financial service like Empower or Facet Wealth offers the benefits of both a digital tool and an in-person financial advisor.

Exploring self-employed retirement options

The solo 401(k) is one of the most popular options for self-employed retirement savings. However, there are some other options to consider. Here are a few:

  • SEP IRA: A SEP IRA — short for Simplified Employee Pension Plan — is similar to a solo 401(k) in that it allows business owners to save a large amount of money for retirement. It has features similar to the solo 401(k) but is available to business owners with employees. However, if you have employees and choose to open a SEP IRA, you’ll also have to contribute to their accounts.
  • Traditional or Roth IRA: Rather than investing in an account specifically designed for self-employed individuals, you can choose to invest in a traditional or Roth IRA. These accounts offer the same tax advantages as a solo 401(k). However, they have considerably lower contribution limits and don’t allow for contributions from your business. Therefore, they’re better as a complement to a solo 401(k) rather than as a replacement.
  • SIMPLE IRA: A SIMPLE IRA — short for Savings Incentive Match Plan for Employees — is another type of self-employed retirement plan. Like the SEP IRA, it allows business owners to contribute both to their own retirement accounts and those of their employees. However, this type of account has considerably lower contribution limits and inflexible contribution rules.

The bottom line

Saving for retirement often takes a back seat when you’re trying to grow and run a business. After all, you don’t have an employer doing the heavy lifting of setting up the plan for you. However, self-employment makes it perhaps even more important to prioritize your retirement.

A solo 401(k) is one of the best options available to help you save for retirement as a self-employed individual. It can help you save tens of thousands of dollars per year while enjoying major tax advantages.

As you’re setting up your solo 401(k) or other self-employed retirement savings tool, a financial professional can be a valuable asset in helping you open your account and plan your investments.

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Glossary Label
Solo 401(k)
Glossary Definition
A solo 401(k), also known as a one-participant 401(k) plan, is for a company with no employees. A solo 401(k) shares all the characteristics of any other 401(k) plan, but it only covers the business owner and their spouse.

RO3324638-0124

  1. IRS. “One-Participant 401(k) Plans.” January 3, 2024.
  2. IRS. “2024 Limitations Adjusted as Provided in Section 415(d), etc.” January 3, 2024.

 

The Currency editors

Staff contributors

The CurrencyTM, a publication from Empower, covers the latest financial news and views shaping how we live, work, and play. We keep you current on ways to plan, save, and invest for life.

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