For those of you who are self-employed it is important that you save for your own retirement. Building a business is hard work. For business owners who work solo, or who have a spouse and/or a partner in the business with them, a Solo 401(k) may be the right option. Here are five reasons to consider a Solo 401(k).
High maximum contributions
For 2022 the maximum contribution limits are $61,000 and $67,500 for those who will be 50 or over in 2022. For 2023 these limits increase to $66,000 and $73,500. This includes the regular employee 401(k) contribution limits for 2022 of $20,500 and $27,000 for those 50 and over. For 2023 these contribution limits increase to $22.500 and $30,000, plus the employer-funded profit sharing component in both years.
The profit sharing portion can range up to 25% of income, though sole proprietors may be limited to 20% due to the nature of the calculation used to determine their contributions. Check with your financial or tax advisor as to how much you will be able to contribute.
Investment flexibility
A Solo 401(k) can be opened at many popular custodians such as Schwab, Fidelity, Vanguard, T. Rowe Price, and many others. Some self-directed retirement account platforms allow Solo 401(k)s as well. Just like an IRA or a SEP-IRA, you can invest in a range of investment options such as mutual funds, ETFs, closed-end funds, individual stocks and bonds or any other investment vehicle that is offered by the custodian that isn’t prohibited by 401(k) rules.
Contribution flexibility
While the high maximum contributions are an advantage for those self-employed individuals with the income and cash-flow to afford them, there is no requirement for you to make a contribution. You can skip a year if need be.
Another form of contribution flexibility is the ability to make the employee contributions up to the maximum as long as you earn enough. Contrast this to a SEP-IRA where the contribution limit is a maximum of 25% of your income. Your contribution amount could be much lower in years when your self-employment income is lower than normal. As long as you have the cash to make the contribution, the Solo 401(k) would generally allow a larger contribution at lower levels of income than a SEP-IRA.
Easy to open and maintain
Most major custodians and brokerage firms welcome these accounts and make the process of opening and funding your account easy. Generally these firms use a prototype plan and there are very few regulatory or administrative requirements until your account balance reaches the $250,000 level.
Roth options are available
Depending upon the custodian you select, a Solo Roth 401(k) option might be available to you. Just like a 401(k) plan with an employer, the Solo Roth 401(k) option allows larger Roth contributions than the Roth IRA limits. For those whose income is too high for a Roth IRA, the Roth Solo 401(k) can be a good option.
If you are interested in opening a Solo 401(k) here are a few things to keep in mind:
- In order to contribute to a Solo 401(k) for the current year the account must be opened by December 31. Contributions can generally be made up to the filing date, including extensions, for the business. It’s best to check with your tax or financial advisor regarding the latest date for contributions.
- A Solo 401(k) only works for you, a partner, and/or a spouse. If you have employees this is not the vehicle for you. Check with your financial advisor or prospective custodian for more on this.
- If you are interested in a Roth feature and/or the ability to take loans from your account, you will want to make sure that the custodian you are considering offers these features. You will also want to inquire about any and all account fees. Note that any trading fees or mutual fund purchase charges that apply to other accounts at the custodian will generally apply here as well.
The Solo 401(k) can be a great self-employed retirement plan. If you are self-employed you need to start saving for your retirement. You work too hard to put this off any longer and if you don’t save for your own retirement nobody else will do it for you.
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I’m going to open a solo 401(k) account at Vanguard soon. It finally make sense to contribute more and this will help with our tax bill next April.
Thanks for the comment Joe. I’ve looked at the VG solo 401(k) and it looks like a pretty good deal especially if you will investing all or primarily in VG funds/ETFs. Kudos for doing this and good luck.
When evaluating the options for my wife we decided the a Solo 401(k) was definitely a better option for her than the SEP-IRA, mainly because of the contribution flexibility you describe above. I like the fact that it’s not limited to a percentage of your income.
Another benefit came to my attention. I have a pretax IRA, over $250K. I also have an account with deposits that I couldn’t deduct, $50K plus some gains.
Any Roth conversion would be prorated, i.e. about 5/6 of the conversion would be taxed, as the IRS doesn’t care that these accounts are different, it’s one big IRA spread around to different account numbers. Now, once my Solo 401(k) is established, I have the opportunity to transfer the large account, plus the growth from the smaller account, and leave a sum equal to my post tax deposits. Once that’s done, any conversion is for 100% post-tax money, and I’m set up to deposit to an IRA and convert to Roth if I’m still above the Roth limit.
The Solo-401 allows for spousal deposits as well, which sets up my wife to make the same move. 20+ years of tax-free growth on our combined $100K in post-tax IRA money is nothing to ignore.
Thanks for sharing this Joe. This is a great strategy for folks like yourself in this situation.
I believe that the solo 401K is possible even if you have part time employees (working <1000hrs/yr). Is that correct.
Sam thanks for your comment. The Solo 401(k) only works for situations with a sole employee or if a partner and/or a spouse in the business. Otherwise this solution does not work with non-owner employees and you would need to look at another small business retirement plan.
thanks for sharing this
Thanks for taking time and writing such an informative post. It now makes sense in investing in solo 401(k) account. Saving money is such an important task, but doing it the right way will reap you more benefits. People who are looking for solo retirement plan will find great advice in this blog post. Thanks!
I think that the solo 401K is possible even if you are a part-time employee please share your information on this.
Rahul thanks for your comment. A solo 401(k) would be possible for a PT employee if that person had income from a side venture in which they were the owner. It likely would not be doable as a PT employee of a company for that employer’s plan unless the PT employee was an owner of or partner in that company. This is not a definitive answer as I would need to know all of the facts and circumstances. I suggest you consult a knowledgeable tax or financial advisor about the specifics of your situation.
Considering a solo 401(k) is one of the best things to do right now, and that is what I’ve been telling all of my friends. I hope that they’ll reconsider their decision and think about these 401(k)s once more.
Greg thanks for your comment. A solo 401(k) is a great option, but everyone’s situation is different.