Solo 401k: Definition, contribution limits, eligibility, how to set up 

If you’re self-employed or running a small business without employees, the solo 401k is a retirement plan worth considering. 

This plan is a popular option for independent entrepreneurs due to its substantial contribution and tax benefits. 

Learn who qualifies, how it differs from other retirement accounts, and how to leverage it to boost your retirement savings. 

What is a solo 401(k)?

Solo 401(k)s, or one-participant 401(k)s, are tax-advantaged retirement plans for sole proprietors. A key distinction is the business must not have any common law employees, only the owner and their spouse if they are also employed. 

Compared to an employer-sponsored retirement plan like a traditional 401(k), a solo 401(k) allows for higher tax-deductible contributions without comprehensive reporting requirements. A business owner can contribute more than conventional plans by contributing as an employee and an employer.

Employer profit-sharing contributions

One significant perk of solo 401(k)s is that you can contribute up to 25% of your W-2 earnings as an employer or 20% of your net adjusted business income if you’re a pass-through entity. The 2024 IRS compensation cap is $345,000. 

Note: These contributions can fluctuate with your business’s profitability from year to year.

Choosing between traditional and Roth options

The type of account you choose will depend on your current tax situation and future expectations. 

Traditional contributions offer an immediate tax break, deferring taxes until the money is withdrawn in retirement. 

On the other hand, Roth contributions are made with after-tax dollars, allowing your withdrawals to be tax-free when you retire.

Key differentiator: Unlike Roth IRAs, there are no income limits prohibiting you from contributing to a Roth solo 401(k).

Contribution limits and deadlines

Solo 401(k) contribution limits fall under the same IRS code as traditional 401(k)s and other similar plans. 

The 2024 limit is $69,000 for anyone under fifty years and $7,500 for those 50 and older (catch-up contributions). 

Remember, as an employee of your own enterprise, your contributions must be made by December 31st, while employer contributions and those of sole proprietors and single-member LLCs have more time until the tax-filing deadline, usually April 15th of the following year.

By adhering to these timelines, you can leverage the full power of the plan’s high contribution limits for tax-advantaged retirement savings. It’s a balancing act of timing and strategy that can help to amplify your retirement nest egg.

Tax benefits and deductions

Solo 401(k) contributions can reduce your taxable income as a tax-deductible business expense or a personal income tax deduction. Moreover, your investments within the solo 401(k) enjoy tax-deferred growth, meaning that taxes on investment earnings are postponed until you decide to withdraw in retirement.

While these contributions, including employer contributions, lighten your current tax load, they do not affect the self-employment tax, which is calculated on your net earnings before taking 401(k) contributions into account. 

Understanding the tax implications of your contributions and knowing when to pay taxes is crucial to minimizing taxes both now and during your retirement years, ensuring you keep a larger share of your hard-earned money.

Solo 401(k) investment choices 

Solo 401(k) investment options are highly diverse. You can allocate your contributions across a broad spectrum of assets, including but not limited to the following:

• Stocks and bonds
• Mutual funds
• ETFs
• Real estate
• Precious metals
• Cryptocurrencies

While many options exist, some investments are prohibited, including collectibles, specific insurance contracts, and privately held investments, among others. If you’re unsure if a particular asset is allowed in your plan, simply ask your plan provider.

Solo 401(k)s vs. SEP and SIMPLE IRAs

Each retirement account has its own unique features and limitations. Here’s an overview of the three most common small business retirement plans.

Solo 401(k)

A solo 401(k) allows a sole proprietor to contribute as both an employer and employee. This unique benefit can result in higher savings. Moreover, these plans allow contributions of up to 100% of earned compensation (capped at an annual limit) and employer contributions of up to 25% of compensation.

SIMPLE IRA

A SIMPLE IRA is an alternative small business retirement plan. Unlike the solo 401(k), this plan is built for companies with employees. As long as the business has a workforce of less than 100 employees, employers and employees can contribute to the plan. The catch is that employers must make matching or nonelective contributions to their employees’ accounts.

SEP IRA

SEP IRAs only allow employer contributions and require the same contribution percentage for all qualifying employees - a limitation Solo 401(k)s don’t impose. Additionally, if you have multiple businesses, be mindful that employee contribution limits are cumulative across all 401(k) plans.

How do I set up a Solo 401(k)?

Here are the steps to launch a solo 401(k) account.

1. Select a plan administrator.

The administrator is responsible for various IRS requirements like reporting. You can either designate yourself or another trusted professional to fill this role.

2. Secure an Employer Identification Number (EIN). 

This unique tax identifier separates your business’s finances from the plan’s when reporting plan contributions and distributions to the IRS.

3. Select a reputable plan provider.

Find a firm that can offer the right mix of features, support, and fees. The most common choice is a major brokerage firm, but other options are available.

4. Complete a solo 401(k) application with the plan provider.

Your plan provider will need some information to set up your account. Here are some items they’ll need:

• Your name
• Plan administrator’s name (yours or another)
• Your Social Security Number
• Employer Identification Number (EIN)
• Business address
• Income

5. Investment selection

After submitting your solo 401(k) account application and receiving approval, it’s time to select your investments. Your options may vary by brokerage and plan, but generally,    these are the most common traditional securities:

• Target-date funds
• Index funds
• Actively managed funds
• Exchange-traded funds (ETFs)

Access to individual stocks, bonds, CDs, or alternative investments (e.g., commodities) will depend on the platform offering the plan.

 6. Contribution frequency

You can set up automated investments or execute them manually based on a schedule that suits your preferences.

Managing your solo 401(k): Responsibilities and considerations

Sole proprietors must learn to navigate contributions, authorize withdrawals, and maintain meticulous records to comply with Internal Revenue Service regulations. It’s vital to keep detailed records of all plan activities to avoid any operational errors that could lead to issues with the IRS.

• Plans with assets over $250,000 must file Form 5500-EZ annually, and all plans must file upon termination or rollover. 
• Distributions before age 59 1/2 typically incur taxes and penalties unless an exception applies. 
• Remember to take your Required Minimum Distributions (RMDs) starting at age 72 or 73, depending on your birth date, to avoid a hefty 50% penalty tax.

Get expert advice on your small business retirement plan options.

Integrating your Solo 401(k) into your overall financial plan

You should strategically integrate your solo 401(k) into your broader financial plan. By maximizing your contributions, especially in years of higher income, you can accelerate the growth of your retirement savings. Moreover, consider including your spouse’s income in the plan to effectively double your savings.

Final word

Solo 401(k)s offer control and flexibility for self-employed professionals looking to save for retirement. This plan distinguishes itself with its high contribution limits and Roth options. Whether you’re a freelancer, contractor, or small business owner, integrating the solo 401(k) into your financial strategy could lead to a more prosperous, tax-advantaged, and secure retirement.

Frequently Asked Questions

Can you get a 401k as an individual?

Yes, as a self-employed individual or a small business owner without employees (or with only a spouse as an employee), you can set up and contribute to a solo or Individual 401(k) plan. This allows you to take advantage of high contribution levels and aggressive savings for the future.

What are the rules for solo 401(k) withdrawal?

You can generally make distributions from a solo 401(k) after a triggering event, such as termination of employment or retirement. However, early withdrawals may be subject to a 10% penalty and applicable income taxes.

Can I contribute 100% of my salary to my solo 401(k)?

Yes, you can contribute up to 100% of your earned income to your solo 401(k) as long as it adheres to the annual IRS contribution limits.

What is the downside of a solo 401(k)?

The solo 401(k) has the same drawbacks as typical 401(k) plans, such as taxes and penalties for early withdrawal. Additionally, setting up and managing the plan can be more intensive, requiring annual IRS forms and potentially higher fees.

Who is eligible to open a solo 401(k)?

Solo 401(k)s are designed for self-employed individuals with no full-time employees other than a spouse who may be involved in the business, such as sole proprietors, freelancers, contractors, and small business owners operating as LLCs, corporations, or partnerships without common law employees.