As a self-employed individual for the majority of my adult life, I’ve found there are many perks of self-employment. But one thing that may keep some people from taking the leap to being their own boss is the lack of an employer-sponsored retirement plan such as a 401k.
Enter the Solo 401k, a tax-advantaged qualified retirement plan for the self-employed individual. The Solo 401k not only allows a business owner to save money for retirement; it also makes it extremely easy to supercharge one’s contributions for maximum tax-benefits and retirement savings over all the other self-employed retirement plans and even the traditional 401k.
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What Is A Solo 401k
The Solo 401k has many names. It has also been referred to as a Self-Employed 401k, Individual 401k, One-Participant 401k, Solo-k, Uni-k, and One-Participant k. The IRS officially calls it a One-Participant 401k.
No matter what new confusing name they might come up with next, it is still exactly what it sounds like: a 401k plan for a business owner and their spouse. A business with multiple partners can all participate in a Solo 401k plan as long as there are no employees in the business.
Qualifications and Eligibility To Contribute To A Solo 401k
Any business entity is eligible to set up a Solo 401k. This includes sole proprietorships, limited liability companies, partnerships, S corporations, and C corporations.
The Solo 401k has no age, income, and years of service restrictions. To establish and contribute to a Solo 401k, you only need to generate self-employment income.
You can be self-employed in your business part-time in addition to having full-time employment elsewhere. This is great for people who have a side hustle, are independent contractors or freelancers. A person may even participate in an employer’s traditional 401k plan in addition to their own Solo 401k. In such a situation, the employee salary deferral contributions from both plans are subject to the total $22,500 (or $20,500 for 2022) contribution limit for the year.
A business owner is eligible for a Solo 401k even if they hire independent contractors and part-time employees. Under federal law, you may exclude the following types of employees from consideration: employees under 21, employees who work less than 1,000 hours annually, union employees, and nonresident alien employees.
Important Solo 401k Deadlines
The deadline to create a Solo 401k is the end of the tax year or December 31 for most people.
The deadline for contributions for sole proprietorships, LLCs, and partnerships is the tax-filing deadline. This is April 15 or October 15 if an extension is filed.
This means that for 2022, if you setup a Solo 401k and sign the adoption documents by December 31, 2022, you have until April 15, 2023 to make both the salary deferral and employer contributions for 2022.
For C and S corporations, the employee salary deferral contribution is done through payroll and the contribution can be made during any time of the year during which the income is earned. This means if you are a huge procrastinator and wait until December to set up your Solo 401k, your December paycheck needs to be large enough to be able to deduct whatever your contribution is. Luckily, you are the boss so you can give yourself a big Christmas bonus. The employer profit-sharing portion of the contribution must be made before the corporation’s tax-filing deadline.
Solo 401k Contribution Limits
The total Solo 401k contribution limits are $61,000 for 2022 and $66,000 for 2023. There is also a catch-up contribution of $6,500 for those who are 50 or older.
What makes the Solo 401k such a great retirement investment tool is that as a business owner, you can contribute both as the employee AND the employer up to the maximum contribution limit for the year.
As an employee, you can contribute up to $22,500 for 2023 (or $20,500 for 2022), up to 100% of compensation for the elective deferral portion. If you are over 50, the $6,500 catch-up contribution is added here. This is similar to a traditional 401k plan.
For the employer side, you can contribute up to 25% of your compensation. If you are self-employed (a sole proprietor or partner in a LLC), your contribution is up to 25% of your adjusted earned income, which is calculated as business income after deducting half of your self-employment tax and divided by 1+your contribution percentage.
Borrowing From A Solo 401k
Can you borrow money from a Solo 401k like a traditional 401k? Yes you can, although I generally don’t recommend touching your retirement funds and letting them compound and grow over time.
This sets a Solo 401k apart from other IRA-based retirement plans, such as the SEP-IRA, SIMPLE IRA, and SARSEP, all of which cannot offer participant loans.
However, not all Solo 401k providers allow loans, so you should check with your provider or potential provider if this is something you are considering.
Once a Solo 401k has been funded, a participant loan may be processed so there is no waiting period as long as the plan has loan provisions that allow for participant loans.
A participant may borrow up to $50,000 or 50% of their account value, whichever is less.
To take a loan from your 401k, you must meet the following IRS requirements:
- A plan loan must be repaid within five years unless it is used to purchase a primary residence
- Payments must be made at least quarterly
- You must charge a reasonable interest rate consistent with rates charged by commercial lenders. A reasonable rate can be the prime rate plus one percent
If you take out a loan and cannot repay it or if you take out a loan that exceeds the maximum allowable amount, it is considered a distribution and you will be subject to income tax and the 10% early withdrawal penalty if you are not over 59.5 years old.
Roth Solo 401k’s Are Available Too
If you think your income will be higher in retirement or if you are in a lower tax bracket now, you have the option to open a Roth 401k. You will pay taxes on the elective salary deferral contribution and can take distributions tax-free later in retirement. The employer profit-sharing contributions are still pre-tax as normal.
Other Solo 401k Considerations
A Solo 401k does have additional paperwork that must be filed that the SEP-IRA or SIMPLE IRA doesn’t require. Once your plan’s account balance exceeds $250,000 you must file a Form 5500 annually. If you have a one-participant plan, you may be able to file a one-page Form 5500-EZ.
The due date for the Form 5500 is the last day of the seventh month after the plan year ends, or July 31 for a calendar year plan.
Add the deadline to your calendar as a reminder since it is easy to forget because it is in the middle of the year-long after you’ve forgotten about anything tax-related. The penalty for late filing of Form 5500 is $25/day up to a maximum of $15,000 per plan plus interest.
Why Choose A Solo 401k Over A SEP-IRA
Both the Solo 401k and SEP-IRA have a maximum $66,000 contribution limit for 2023 (or $61,000 for 2022) for those who are under 50 years old.
The Solo 401k and the SEP-IRA also both allow up to 25% of the participant’s compensation for the employer’s profit-sharing contribution limit.
What distinguishes the Solo 401k from the SEP-IRA is the additional $22,500 employee deferral contribution for 2023 (or $20,500 for 2022) that can be made for the Solo 401k plan.
For a sole proprietor or single-member LLC with a net business profit of $100,000 in 2020, the maximum contribution amount for a SEP-IRA is $18,587.
The maximum contribution for a Solo 401k is almost two times that amount at $41,087 ($22,500 elective deferral + $18,587 employer profiting sharing). If you are over 50 years old, you can make an additional catch-up contribution of $6,500 to your Solo 401k plan. This catch-up contribution isn’t available for SEP-IRAs.
Why Choose A Solo 401k Over A SIMPLE IRA
With SIMPLE IRA participants, the maximum elective deferral amount is $15,500 for 2023 ($14,000 for 2022) with a catch-up contribution of $3,500 for those 50 or older.
For the SIMPLE IRA employer contribution portion, the employer can match up to 3% of the employee’s compensation up to $15,500.
A sole proprietor or single-member LLC under 50 with a net business profit of $100,000 in 2023, the maximum contribution amount for a SIMPLE-IRA is $18,270, which is comprised of $15,500 for the employee salary deferral plus the $2,770 employer matching contribution.
Comparing Solo 401k vs SEP-IRA vs SIMPLE IRA
The below table is a summary of the contributions for the different self-employed retirement plans
Contributions For $100,000 Of Self-Employment Income For 2023
|Solo 401k||SEP-IRA||Simple IRA|
|Max Allowed Contribution (<50)||$66,000||$66,000||$22,500|
|Max Allowed Contribution (>50)||$73,500||$66,000||$30,000|
|Adjusted Earned Income||$74,348||$74,348||$92,350|
|Elective Deferral Amount||$22,500||None||$15,500|
|Maximum Contribution (<50)||$41,087||$18,587||$18,270|
|Maximum Contribution (>50)||$48,587||$18,587||$21,770|
How To Open A Solo 401k Account
There are many online brokers available that offer Solo 401k accounts. The biggest and most popular ones are Vanguard, Fidelity, Schwab, TD Ameritrade, and E-Trade. Each provider has their own investment options that can include mutual funds, index funds, stocks, bonds, and ETFs. Be sure to research any fees, commissions, and minimum balance requirements.
For those who might want to take out a loan from their 401k, both TD Ameritrade and E-Trade allows you to borrow against your account.
Vanguard, TD Ameritrade, and E-Trade has Roth 401k’s available.
Before opening an account, you will need to get an Employee Identification Number from the IRS by going to their website. Applying for an EIN takes only a few minutes and you will get your number immediately upon submitting the online application.
Once you’ve chosen your provider, you will need to complete an account application and plan adoption agreement.
The difference in contributions that you can make to a Solo 401k over the SEP-IRA or SIMPLE IRA can result in thousands of dollars saved on your taxes. For someone in the 25% tax bracket, the additional $22,500 in employee contributions is a tax savings of over $5,625 just in itself.
Not only can you make the same contribution amount as a regular employee who works at a job for the employee deferral part, you can contribute up to 25% of your business’ profits towards your retirement, which is usually more generous than what a company would be willing to match in a traditional 401k plan for the same amount of income.
By contributing to a qualified retirement plan, you are also reducing your taxable income, which could make you re-eligible to contribute to a Roth IRA if your income was too high before.
Another benefit of a 401k that could be important for a business owner is that it is exempted from bankruptcies, and depending on the state, is afforded protection from creditors as a result of debt or civil lawsuits.
If you are just now coming across this post and it is too late to set up a Solo 401k for your 2022 taxes after missing the December 31 deadline, but is still not yet April 15, you can still save for retirement and reduce the amount of taxes you owe to the IRS by setting up a SEP-IRA account now. The deadline to open and make contributions to a SEP-IRA is your tax-filing deadline, including any extensions.
Do you have a Solo 401k? Which provider are you using? If you do not, which retirement plan option did you choose?