Solo 401(k)s for the Self-Employed

Self-employment is an exciting option for many of us. Whether you work for yourself full time or as a side gig in addition to your regular full-time employment, self-employment can be both personally fulfilling and financially rewarding.

As fulfilling as self-employment is, it’s still a business, and taxes and your business accounting are important. So is saving for your own retirement. One of the best options could be a solo 401(k).

What is a solo 401(k)?

A solo 401(k), sometimes referred to as an individual 401(k), allows you to contribute as both the employee and the employer. A spouse involved in the business can contribute to a solo 401(k), as can any partners who are owners. Employees who are not owners of the business must use other savings vehicles.¹

Prior to the passage of Secure 2.0, profit sharing contributions to a solo 401(k) had to be made to a traditional solo 401(k) account. With these new rules in place, profit sharing contributions can now be made to either a traditional or Roth solo 401(k) account.²

Contributions to a Roth solo 401(k) are made on an after-tax basis, grow tax-free in the account, and can be withdrawn tax-free in retirement as long as certain requirements are met. Contributions to a traditional 401(k) are made on a pre-tax basis, grow tax-deferred in the account, and are taxed as they’re withdrawn. Both vehicles have specific contribution limits and deadlines.³

Advantages of a solo 401(k)

• Unlike a Roth IRA, the Roth solo 401(k) has no income limitations. It also offers high annual contribution limits.

• You may take loans from your solo 401(k), just like you may from traditional employer-sponsored 401(k) plans. Traditional IRAs don’t allow for loans.

• Because you’re contributing as both the employer and the employee, you’re allowed to contribute a significant amount each year.

• A solo 401(k) is easy to open at most major online brokers and other institutions. There is very little maintenance or reporting on these plans, though this can increase a bit once the plan assets exceed $250,000.¹  

• Both employee and employer contributions are flexible, and are not required in any particular year. In the case of employee contributions, they can be made up to the lesser of your actual compensation from the business, or the annual 401(k) contribution limits.

• With a solo 401(k), you can invest in a wide range of investment vehicles, including mutual funds, ETFs, individual stocks and bonds, cash, and a host of others. Self-directed account providers generally allow a range of alternative investments in addition to the more traditional types.

Disadvantages of a solo 401(k)

• Once the plan reaches $250,000 in assets, there are increased reporting requirements.¹

• Regular employees are not allowed to participate. If you plan to hire employees in the near future, this won’t solve for helping them save for retirement.

Solo 401(k) contribution limits

The employee limits are the same as with an employer-sponsored 401(k). For 2024, the contribution limits are $23,000. For those who are age 50 or over, they can make up to an extra $7,500 in catch-up contributions for a total of $30,500.¹

The solo 401(k) also allows for employer profit sharing contributions. These contributions are considered business expenses and can be made for the owner and an eligible spouse up to 25% of their compensation from the business. The maximum combined contribution amount for 2024 is $69,000; for those who are 50 or over it’s $76,500.¹

If you are working at a day job and are self-employed as a side gig, you can still contribute to a solo 401(k), but your total employee contributions cannot exceed the annual 401(k) employee contribution limits.

Even if you have maxed out your 401(k) from your day job employer, you can still take advantage of the employer profit sharing contribution feature of the solo 401(k).

Opening a solo 401(k)

A solo 401(k) can be opened at most major brokerage firms and can be opened online. In order to be eligible for employee contributions for the current tax year, the account must be opened by December 31 of the current year. Employer contributions for the prior tax year can be made as long as the plan is opened by the filing date for the business, including extensions.⁴

SEP-IRA versus solo 401(k)

A SEP-IRA is often considered the main alternative to a solo 401(k) for many self-employed people.

SEP stands for simplified employee pension. A SEP-IRA is a version of an IRA that allows the self-employed to make employer contributions to an account up to the lesser of $69,000, or 25% of their compensation for 2024. No employee contributions are allowed, and there is no catch-up for those who are 50 or over.⁵

A SEP-IRA does allow the business owner to make contributions on behalf of employees, but they would need to contribute the same percentage of pay for these employees as they contribute for themselves.

Here is a comparison between these two types of plans.

A solo 401(k) is typically a better choice for someone who wants more flexibility around making contributions. At lower levels of income, a solo 401(k) will allow greater contributions. For example, someone with $50,000 in compensation who is under age 50 could contribute $23,000 in employee contributions plus another $12,500 in employer contributions for a total of $35,500 for 2024.

By contrast, that same person with $50,000 in compensation would only be able to contribute $12,500 to a SEP-IRA for 2024 based on 25% of their compensation.

A SEP-IRA may be a better choice for those who want flexibility around when they would open the account and/or fully fund it for the prior tax year or if the business plans to add employees in the near future.

Other alternatives to a solo 401(k)

There are other alternatives to a solo 401(k) that the self-employed can consider.

• SIMPLE IRAs are retirement plans available to businesses with 100 or fewer employees, including the self-employed. The contribution limits are lower than for a solo 401(k), and there can be restrictions on rollovers within the first two years the plan is opened.
• Traditional and Roth IRAs are both solid retirement savings vehicles. IRAs have a much lower annual contribution limit and there may be income restrictions regarding types of contributions. IRAs are an excellent destination for money rolled over from retirement plans if you leave an employer.
• Small business 401(k) plans can be a solid, albeit expensive to offer and maintain, option when a business has employees. These plans will have the normal reporting and administrative requirements that an employer-sponsored 401(k) has.

Depending upon your situation, there may be other types of retirement plans you can consider as a self-employed person.

Is a solo 401(k) right for you?

If you’re self-employed and don’t plan to hire employees in the near future, a solo 401(k) can be an easy option to save for your retirement. Because there are alternatives, you may want to discuss your options with a certified accountant.