A solo 401(k) is a retirement account designed for self-employed individuals with no employees (aside from a spouse). They’re desirable because they have higher contribution limits than other types of retirement accounts, which can give them great tax advantages.
Other names for a solo 401(k) are:
If you’re a self-employed individual, you probably want to know if a solo 401(k) will make sense for you and your business. Let’s break down its benefits, features, and drawbacks.
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How does a solo 401(k) work?
A solo 401(k) works best for an individual who has no full-time employees (other than a spouse) and doesn’t expect to add employees in the future. This is because the Internal Revenue Service (IRS) allows for self-employed individuals to contribute as if they are both the employer and the employee in a solo 401(k). This raises the amount you can contribute to a retirement plan to a maximum of $69,000 (not including $7,500 in catch-up contributions you can make after age 50).
This is beneficial in years when you make more money because you’re able to reduce your taxable income by taking a deduction from your business expenses when you make retirement account contributions.
Self-employed individuals might also like choosing their own retirement plan provider and the investment options with a solo 401(k).
Solo 401(k) contribution limits
One of the defining features of a solo 401(k) is how much you’re able to contribute to the account. Here’s how it breaks down.
- Employee maximum contributions are $23,000 in 2024, $30,500 if age 50 or over.
- Employee and employer maximum contributions combined are $69,000 for 2024, $76,500 if 50 or over. As a business owner who is both the employer and employee, you can contribute this higher amount to your plan.
Solo 401(k): Pros and cons
Pros:
- Higher contribution limits at $69,000 (or $76,500 at age 50 and over).
- Business owners can contribute double the amount into the account—both from the ownership side and the employee side.
- Helps minimize self-employment tax bill by reducing taxable income.
- Can choose from either pretax 401(k) or Roth tax strategies.
- Flexibility in choosing a provider, plan, and investments.
- Loans and hardship distributions may be possible.
- Accepts rollovers from other 401(k) accounts.
Cons:
- Generally, distributions aren’t allowed until age 59½.
- If you’re under 59½, triggering events that allow for early distributions may be subject to a 10% penalty in addition to any tax you would owe.
- Tax is paid when funds from a non-Roth 401(k) are distributed and taxed as ordinary income.
Advantages
A solo 401(k) has some advantages that can help you contribute more to your retirement while reducing the amount of taxes you owe.
Higher contribution limits
Because a solo 401(k) allows you to contribute as both the employer and the employee, you can max out your retirement contributions att $69,000 ($76,500 if you’re age 50 or over).
Reduce taxable income
Contributing to a retirement account can keep more money in your pocket and reduce your tax bill. The employer portion of retirement account contributions can be claimed as a deduction against your business expenses, which reduces your income and, in turn, reduces the amount of tax you’ll owe. The employee part of your contributions can reduce your taxable income— unless the account is set up as a Roth 401(k), in which case your employee contribution will be from after-tax income. Consult a tax advisor before setting up your plan to explore your options.
Plan may allow for loans or hardship distributions
A solo 401(k), depending on how you set it up and what the plan allows, can start distributions for qualifying events. Some may also allow for loans. Just be aware there may be a penalty for some early distributions.
Flexibility in choosing a provider, plan, and investments
When you’re self-employed, you have the option of choosing your own retirement plan provider, type of retirement plan, and what investments you make within that plan. You may want to consult with a financial advisor, such as those from Empower.
Can roll over retirement money from another account
When you open a solo 401(k), you can roll over money from a previous tax-advantaged retirement account, such as a 401(k) from a previous employer, into your new account.. There are services, such as Beagle, that can help you find these old 401(k)s to accomplish this goal.
Special considerations
Before you decide on a solo 401(k), there are a few things of which you’ll want to be aware.
Early withdrawal penalties
If you are self-employed and possibly looking to retire early, you should know that the penalty for withdrawing money before age 59½ from a solo 401(k) is 10%. If you’re going to need your money earlier, you’ll want to look at other retirement vehicles.
If your business grows
If you add employees at a later date, you’ll need to convert your solo plan to a traditional 401(k) or terminate it. This is regulated by the IRS.
Legal entities
It is possible for certain legal entities to invest in a solo 401(k). The main restriction is full-time employees—you can’t have any except your spouse. However, the following are allowed to open solo 401(k)s as long as the business only includes you and a spouse.
Large retirement account balance
Once your account reaches $250,000, or when you close the account, you’ll need to file IRS form 5500.
How to open a solo 401(k)
Solo 401(k)s are marketed by most retirement plan providers. It’s similar to opening a traditional 401(k), but you need an employer identification number (EIN) to open one. If you don’t have one, you can easily get one online.
From there, you can:
- Choose a provider.
- Open the account.
- Set up contributions.
- Choose investments.
- Adjust as necessary with time.
The basics are easy. What you’ll want to spend time on is researching which provider is best for you, then which investments you want to make. If that sounds like more than you want to do yourself, you can consult with a financial advisor, such as those from Empower.
Is a solo 401(k) worth it?
There are a few situations in which a solo 401(k) makes a lot of sense.
When you need to offset a large amount of income. A solo 401(k) may allow you to deduct retirement contributions. With the larger contribution limit of $69,000, you may be able to reduce your tax liability with retirement contributions.
When you need to build a retirement account quickly. If you’re older and need to maximize your retirement contributions, a solo 401(k) can help. You can make a large amount of contributions to the account to build a retirement fund quickly.
Alternatives to a Solo 401(k)
If you’re looking for more retirement options, take a look at these alternatives:
A solo 401(k) can help self-employed individuals ramp up retirement contributions
A solo 401(k) has a number of advantages. It allows you to build up your retirement account quickly while offering tax advantages like a typical 401(k): tax-free growth on the account and reduced tax liability on your income.
There are a wide range of providers who can administer your solo 401(k). If you’re new to self-employment, you can roll over an old 401(k) into a solo 401(k). Just, be sure to review the alternatives listed above before you make your final decision.
Frequently asked questions (FAQs)
Can you cover your spouse under your solo 401(k)?
Yes, a spouse can participate in a solo 401(k) plan.
What is the difference between an individual 401(k) and a solo 401(k)?
They are generally considered to be the same thing.
What happens to solo 401(k) when you are no longer self-employed?
You may be able to roll over the solo 401(k) to another retirement plan when you’re no longer self-employed. Just keep in mind that the rollover may have tax consequences if you switch from a pretax account to a Roth or vice versa.
Empower Personal Wealth, LLC (“EPW”) compensates Time Stamped for new leads. Time Stamped is not an investment client of Empower Advisory Group, LLC.
