Starting a Business? What to Know About Solo 401(k) Plans

Are you self-employed, or a small business owner, with no employees (or just you and your business partners), and you want to reduce your tax burden now, plus save for retirement? If so, you might want to consider a solo 401(k) plan.

Are you a solo-preneur? For example, nearly a third of millennials are self-employed and running start-ups. There are many benefits to running your own business, including the ability to follow your passion, call the shots, and often choose your own hours. But when you’re the “chief everything officer,” sometimes saving for retirement is relegated to the back burner. Plus, you may not have thought about how to reduce your tax bite—until tax time when it might be too late.

What Is a Solo 401(k) Plan, and Who Qualifies for One?

The solo 401(k) plan—or what the IRS calls a “one-participant 401(k)”is a savings retirement vehicle that may allow you to maximize personal retirement contributions as well as take advantage of business deductions.

Anyone who owns a small business, is an independent contractor, or is self-employed, can open and contribute to a solo 401(k). The one caveat is that you can’t have any employees other than your spouse (or other owners of the business).

Solo 401(k) plans offer higher contribution limits compared to individual retirement accounts (IRAs)—often contributions are larger than other small business retirement plans like SEP-IRAs or profit sharing plans. They have a low administrative cost and are relatively easy to set up. There are potential tax benefits—especially the ability to put away those savings before taxes. And they offer access to a large set of investments.

Also, like IRAs, solo 401(k) contributions can be structured in two ways: traditional and Roth. With a traditional solo 401(k), contributions are deducted from your top-line income, and federal taxes are deferred until withdrawal. With a Roth, contributions are taken after-tax, but gains are tax-free upon withdrawal. Roth contributions are limited to the 401(k) limit of $22,500 for 2023, up from $20,500 in 2022 (or $30,000 for 2023 if you’re 50 or older). Only certain 401(k) plans allow Roth contributions. The TD Ameritrade solo 401(k) plan no longer allows Roth contributions as of December 1, 2022. Learn more about the difference between traditional and Roth plans, and how to choose which is right for you. 

Being Your Own Boss, Literally

Many business owners can contribute more (or even max out) to a solo 401(k) than to other small business retirement plans because owners are considered to be both employees of the business and the employer. You wear two hats and contribute part of the money as the employee and the rest as the employer. For 2023, the employee contribution limits for those younger than 50 for a solo 401(k) are $22,500 (or if you’re 50 or older, you can make up to an additional $7,500 in catch-up contributions). Plus, as the employer, you can also contribute up to 25% of your “earned income.” Total contributions, however, may not exceed $66,000 in 2023 (or $73,500 if you’re 50 or older).  

Sound confusing? Have your Schedule C (or K-1) “Net Profit” handy and try our Contribution & Eligibility Calculator to see how much you can contribute to a solo 401(k)—whether you want to maximize your contributions or model a lower contribution.

And if you want a solo 401(k) for 2022, you may still have time. You can open one as late as your business tax filing deadline, including through your extension date.

In addition to contributions to a solo 401(k), you may be eligible to contribute to a regular IRA that may or may not be deductible. That will depend on your adjusted gross income, and it may be best to talk with your tax advisor about your own unique circumstances.

The Caveats

Like IRAs and other 401(k) plans, you may begin withdrawing the money at age 59 1/2, and you’ll be required to take a certain minimum amount each year, called a required minimum distribution (RMD), once you reach age 72. And don’t forget that 10% early withdrawal penalty if you’re younger than 59 1/2 (exceptions may apply).

While there is less administration than a typical large company 401(k) plan, your solo 401(k) may require some extra assistance or work on your part. Once your plan assets reach $250,000, you’ll need to file a special form with the government. Called a 5500 EZ, it’s required once you terminate your solo 401(k) too.

A solo 401(k) plan must be set up by your tax filing deadline (including your extension date if you have one) in order for you to make a contribution that year. To contribute for 2022, for example, a sole proprietor with no extension would need to set up the plan and make the contribution no later than April 18, 2023. If you miss that deadline, you can still open a solo 401(k) plan, but any contributions will be for tax year 2023.

Also, remember that you can’t have any employees other than your spouse (who actively works for the business) or your business partners (and/or their actively employed spouses who work for your business) to qualify. You cannot contribute to a solo 401(k) if you have non-owner employees of the business that work more than 1,000 hours per year (about 20 hours per week). Your business can employ part-time workers as long as no one employee exceeds the 1,000 hours of service per year threshold, and you make this exclusion when you complete your solo 401(k) paperwork.

Plus, 1099 contractors are not viewed as employees and do not impact your ability to offer this plan. You do need to be sure that a person providing services to your business legally qualifies as an independent contractor per your state laws and should not be considered a true employee of the business. Certain types of union employees and non-resident alien employees can be excluded from the plan too. Employees younger than 21 may be excluded as well—again as long as your paperwork specifies this.

Need help figuring out if your employees might be eligible for your plan? Try our Small Business Retirement Plan Contribution & Eligibility Calculator. This unique tool can also help you calculate how much you could contribute to your solo 401(k) and even compare that with a SEP-IRA instead.

Finally, if you’re a business owner who is also employed by a second company, and you participate in that company’s 401(k) plan, the IRS wants you to know that limits on elective salary deferrals are by person, not by plan. You’ll need to consider the limit for all elective deferrals ($22,500 for 2023) you make during a year.

Getting Started

No matter which savings vehicle you choose, it’s just important to get started. Developing a habit of automatic retirement investments may help you become better prepared for retirement. Consider contributing to your solo 401(k) via direct deposit at least monthly. Even a small amount can pay off in the end.