What is a Solo 401k?

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A Solo 401(k) is one of the most effective ways to save for retirement as a small business owner. You can enjoy generous contribution limits, employer-side contributions and flexible investment options.

However, it’s easy to overlook this retirement account as it doesn’t receive as much attention as other retirement solutions. Here are reasons why I chose a Solo 401(k) for my business retirement plan instead of other popular options.

What is a Solo 401(k)?

Simply put, a Solo 401(k) is a 401(k) for a business with just one employee – the business owner. It’s sometimes called a Self-Employed 401(k) or an Individual 401(k).

Technically, you can have two employees – the business owner and his or her spouse. If you have any additional employees, you aren’t eligible to open a Solo 401(k). Still, it’s a robust freelancer retirement plan that’s underutilized by many solopreneurs.

Similar to a workplace 401(k), it has substantially higher contribution limits than the more prevalent traditional or Roth IRA. The generous limits make it easier to maximize tax-advantaged investing. Additionally, you can still contribute to an IRA and health savings accounts as a three-pronged approach to reduce your lifetime taxes.

Contrary to most workplace plans, which may only offer a handful of mutual funds to choose from, many solo 401(k) providers offer ample investment options, including stocks, ETFs, mutual funds, and options.

So, you can get ample flexibility to trim your taxable income with pre-tax contributions and enjoy tax-deferred tax treatment on your investment gains. Fortunately, since 2023, providers may offer a Roth Solo 401(k) option for tax-free withdrawals on your retirement income.

Contribution Rules

You’re allowed to contribute $69,000 in 2024 or 100% of earned income, whichever is lower. This amount is split into two parts.

Employer Contribution: As an employer, you can contribute up to 25% of your compensation. If you are a sole proprietor or a single-member LLC, you can contribute 25% of net self-employment income (profit minus half of your self-employment tax and plan contributions).
Employee Contribution: As an employee, you can contribute up to $30,000 or 100% of your compensation, whichever is lower. If you are over 50, your employee limit is increased to $37,500 as a catch-up contribution.

The limits for the Solo 401(k) are, per person, shared across all 401(k) plans. If you are contributing to a 401(k) outside of your business, you need to adjust your limits to account for those.

Without getting too specific, the contribution deadlines depend on your type of business entity. For sole proprietors, it can be April 15, but for LLCs, S-Corps, and partnerships, it can be March 15.

Also, the withdrawal rules for a 401(k) still apply including required minimum distributions (RMDs) starting at age 73 for traditional accounts and waiting until age 59 ½ to make penalty-free withdrawals.

For example, my wife has two 401(k)s – one from her primary employer and one from our business. Her employer doesn’t offer any 401(k) match, so for simplicity, we only contribute to our business’ Solo 401(k). If her primary employer offered a match, we’d contribute as much as needed to maximize that match and then reduce her contribution to the business Solo 401(k).

Tax Treatment

Traditional solo 401(k) contributions are tax-deferred meaning you reduce your taxable income for the contribution year. Instead, you pay income taxes when you withdraw money in retirement.

Roth Solo 401(k) contributions require paying income taxes upfront but grow tax-free. This can be a more appealing option if you don’t want a tax surprise in retirement or if you anticipate being in a higher tax bracket during retirement than your working years.

You must designate if you want to open a Roth or traditional 401(k) and which tax treatment you want for the employee and employer contributions. Passage of the SECURE 2.0 Act on December 31, 2022, allows an employer’s matching contribution to fund tax-free Roth accounts too.

Alternatives to Solo 401(k)

There are several retirement accounts available to business owners.

Solo 401(k) vs SEP IRA

A SEP IRA is a close alternative and structured similarly to a traditional IRA with similar contribution limits to the Solo 401(k).

This retirement plan type has more restrictions, although it’s best for profit-sharing between owners and employees. It’s also possible to open a Solo 401(k) and an SEP IRA, as they’re different product types, and the contribution limits don’t overlap.

Contribution Rules

As the employer, you’re allowed to contribute $69,000 in 2024 or up to 25% of compensation (or net self-employment earnings). The contribution is tax-deductible, and your distributions are taxed as income. You don’t make any contributions as an employee.

If you have employees, you (as an employer) must contribute an equal percentage for each employee. If you, as an employer, contribute 5% of your salary to a SEP IRA, you have to contribute 5% of every eligible employee’s salary to their SEP IRA.

Lastly, there is no catch-up contribution for the SEP-IRA (because there’s no employee contribution).

Solo 401(k) vs IRA

A pre-tax traditional IRA or a post-tax Roth IRA might be the default retirement savings option, as these accounts are the most common for good reason. They are easy to set up, have nearly unlimited investment options, and are offered by most online brokers since they are connected to each person instead of a particular business.

You may also consider this account type to hold IRA-eligible alternative investments like precious metals, crowdfunded real estate, or physical assets. A self-directed IRA is necessary in this situation as stock brokerages don’t support these asset types.

The only core requirement for opening an IRA is proof of earned income. It can be from self-employment sources reported on tax form 1099 or W2 income as an employee.

Disadvantages include low annual contribution limits and no employer contributions since it’s an individual retirement account (IRA) instead of a workplace retirement plan.

Contribution Rules

Individuals can contribute up to $7,000 in 2024 or 100% of the earned income, whichever is smaller. There is a $1,000 catch-up contribution if age 50 or older for an $8,000 combined limit.

This is the combined annual contribution limit between all accounts for one person. Your spouse must open a separate IRA. So, a dual-income household can contribute up to $14,000 in 2024 ($16,000 if both are at least 50 years old).

Despite the smaller annual contribution limits, a bit of good news is that you can contribute to a 401(k) and an IRA in the same year since they are separate products.

Additionally, the annual contribution deadline is the federal tax deadline (April 15 most of the time). The longer window means you can make contributions in the spring while preparing your tax return and need a last-minute tax deduction. It can also help you max out your Solo 401(k) first and then focus on your IRA with your remaining take-home pay.

Solo 401(k) vs SIMPLE IRA

A SIMPLE IRA is available to companies with 100 employees or fewer. SIMPLE stands for “savings incentive match for employees” (they really bent over backwards to make that work!).

The hallmark of a SIMPLE IRA is that the employer must offer an incentive to contribute to the plan. The employer must match employee contributions, dollar for dollar, up to a maximum of 3%. Alternatively, the employer can contribute a flat 2% of the employee’s salary without the employee having to contribute anything.

For example, in a SIMPLE IRA that matches up to 3%, an employee earning $100,000 must contribute $3,000 to the SIMPLE IRA to get the maximum match from the employer. The employer matches dollar for dollar up to 3% of the employee’s salary. Alternatively, the employer could set up a plan that offers a 2% flat contribution for that employee. In that case, the employee gets a $2,000 contribution to their SIMPLE IRA without any participating requirements.

The difference is, with a SIMPLE, the employer must offer a match. With a 401(k), the employer has the option. Besides this distinction, it operates similarly to a 401(k) in that contributions are pre-tax, and there’s a 10% penalty if you withdraw funds before age 59 1/2. The penalty is 25% if you withdraw the money within two years of signing up for a plan.

Contribution Rules

Employer Contribution: The employer can match an employee’s contribution dollar for dollar up to 3% of their salary or a flat 2% of their salary, with no employee participation.

Employee Contribution: For 2024, you can contribute up to $16,000. Workers who are 50 and older can contribute an additional $3,500 more as a catch-up contribution.

If you run a one-person business, the Solo 401(k) can be better as you have more flexibility with the matching contributions and higher employee contribution limits. As this is an IRA, it can reduce your traditional or Roth IRA contribution capability, but it has less administrative burden.

Which is Best For Your Business?

If you have employees, besides you and a spouse, you’re limited to a SEP IRA or SIMPLE IRA. If it’s just you, then the Solo 401(k) is an option.

Of the three, the Solo 401(k) allows you to defer the highest amount of income because you can contribute as both an employee and an employer. It shares the same employer contribution limit as the SEP-IRA, but it adds the employee contribution component, which results in a higher total deferral, plus you can add your spouse. The Solo 401(k) is only available for those without employees.

The downside is that the Solo 401(k) requires more paperwork including potentially an annual filing of Form 5500. I didn’t know about this filing for the first few years of the plan and faced a stiff penalty for not filing this (relatively) simple form. You must file this form once you have at least $250,000 in plan assets and your 401(k) provider should provide how-to resources. It’s pretty easy, especially after the first year

The SEP-IRA is difficult if you have employees and want to maximize your deferred income because the employee contribution must be the same for all employees. The SIMPLE IRA is a good option if you just want to set up a run-of-the-mill retirement plan for your employees and aren’t looking to minimize income.

Also, considering a Roth? Here are the differences between a Roth and 401(k) and when to use each.

Remember that you can contribute to a traditional and Roth IRA regardless of your business type, as these accounts sync with your earned income instead of your business size.

Best Solo 401(k) Providers

Which provider is best for you will largely depend on what you’re looking for in a 401(k) plan administrator regarding investment options, ease of use, and account service fees.

Below are some of the best Solo 401(k) plan providers to choose from.

Fidelity

Fidelity offers a self-employed 401(k) plan without account fees or minimum balance requirements. Additionally, there are $0 trade commissions for online U.S. stock, ETF, and options trades. Fractional stock and ETF shares start at $1 through the mobile investing app.

You can also invest in bonds, CDs, and Fidelity and non-Fidelity mutual funds or ETFs potentially commission-free. Its Fidelity ZERO index mutual funds don’t charge any fund fees.

See if you’re eligible for the latest Fidelity Investments promotions.

Carry Money

Carry Money’s Solo 401(k) provides the most flexibility as you can invest in many asset classes within your account. Investment options include stocks, ETFs, crypto, real estate, and private equity.

In addition to the typical services, they offer support for performing a Mega Backdoor Roth. Their basic plan costs $299 per year but also has a 30-day money back guarantee, so you can look around first. Pro and VIP plans are also available that provide financial advisor access and more personalized planning tools.

Charles Schwab

A Charles Schwab Individual 401(k) plan has no account fees or minimum balance requirements. Enjoy $0 online trades for stocks, ETFs, thousands of mutual funds, in-depth charting tools, and analyst reports. A per-contract fee applies to options.

Fractional shares start at $5 for S&P 500 individual stocks, making it easier to get exposure to some of the biggest companies or fine-tune your asset allocation.

Check out the best Charles Schwab promotions for more.

E*TRADE from Morgan Stanley

E*TRADE from Morgan Stanley offers fee-free Solo 401(k) plans $0 account fees and minimums. Investment choices with $0 trading fees include stocks, ETFs, and mutual funds. Bonds and options are available as well with competitive per-bond and per-contract pricing.

This platform has well-ranked, hands-on customer service and powerful research tools helpful for short-term trading and long-term investing. You may be eligible for E*TRADE promotions when opening select new accounts.

Read our E*TRADE review for more.

How to Open a Solo 401(k)

Opening a Solo 401(k) is simple, but the paperwork and account maintenance requirements are more extensive than personal investment accounts. Here is a step-by-step approach to start investing with this business retirement account.

Apply with an EIN: You may already have an EIN (Employer Identification Number) from starting a business. If you’re still a sole proprietor or independent contractor using your Social Security number, it’s free to apply for one from the IRS so the 401(k) plan provider can verify your business identity.
Have no employees: This business retirement account is only for sole employees without common law employees. To reiterate, spouses receiving business income are the lone exception.
Be the plan administrator: Typically, the business owner is the plan administrator and plan participant. If you have a spouse, the broker usually requires naming them as the primary beneficiary. You must prepare any upfront and annual plan records or documentation, including Form 5500 (if plan assets exceed $250,000).
Open before tax filing deadline: You must open the account before your business tax filing deadline, which is March 15 or April 15 for most entities, to make same-year contributions.
Choose traditional or Roth accounts: Most providers offer traditional and Roth Solo 401(k)s. You can open either or both and designate how to make employee and employer contributions to optimize your tax situation.
Fund your account: Precise funding methods may vary by brokerage, but you can usually link a free checking account, schedule bill payments from an external banking account, or mobile deposit checks. Plan providers can help you set up automated salary deferrals as well.

As I mentioned earlier, I went with Vanguard as it’s a low-cost provider with highly-rated investment options and I’m familiar with the platform. The setup process was seamless. Unfortunately, the platform has since sold its small-business retirement plans to Ascensus in 2024, but the providers above are excellent alternatives.

Summary

A Solo 401(k) is one of the best tax advantages of being self-employed. You have high contribution limits, many investment options, and more flexibility than most business retirement options or IRAs. It’s worth exploring this option as one way to improve your tax situation and plan for retirement.