If you own a small business with no employees other than your spouse, a solo 401(k) plan could be a smart choice for your retirement planning. It’s also a good option for those who are self-employed or business owners looking to upgrade from a SIMPLE IRA or Simplified Employee Pension (SEP) plan.
Also known as an individual 401(k), a solo 401(k) offers potential advantages like higher contribution limits, tax savings, and more investment options. These accounts are designed for self-employed professionals, including sole proprietors, owners of single-member limited liability companies (LLCs), consultants and other one-person businesses.
How much can you contribute?
A solo 401(k) plan allows you to make large annual tax-deductible contributions. For 2024, you can make an “elective deferral contribution” of up to $23,000 of your net self-employment (SE) income. If you’ll be 50 or older by December 31, that limit increases to $30,500 thanks to an extra $7,500 catch-up contribution allowance.
With a solo 401(k) you can also contribute more than just your elective deferral. Though you don’t technically have an employer, you can make an additional “employer contribution” of up to 20% of your net self-employment income. The best part? Your net self-employment income isn’t reduced by the elective deferrals you’ve already made, meaning you can maximize your total contributions.
For the 2024 tax year, the total contributions to your solo 401(k)—including elective deferrals and employer contributions—can’t exceed:
- $69,000 ($76,500 if you’re 50 or older by December 31, 2024), or
- 100% of your net self-employment income.
Your net self-employment income equals the net profit shown on Form 1040, Schedule C, E or F for your business, minus the deduction for 50% of self-employment tax attributable to that business.
What are the pros and cons of a solo 401(k)?
One of the biggest perks is the ability to make significant, tax-deductible contributions. But the best part is that those contributions are discretionary. If cash flow is tight one year, you can scale back your contribution or skip it all together without penalty.
Plus, if your plan document permits loans, you can borrow up to 50% of your solo 401(k) account balance or $50,000—whichever is less. This flexibility can be a lifesaver when you need access to funds for business opportunities or unexpected emergencies but it is important to note that some plan options, including SEPs, do not allow loans.
The biggest drawback of a solo 401(k) is that setting them up isn’t as simple as opening an SEP or SIMPLE IRA. Expect significant upfront paperwork plus ongoing administrative tasks, like adopting a written plan document and establishing a process for collecting and depositing elective deferrals into the account. When your account balance exceeds $250,000, you need to file Form 5500-EZ with the IRS each year too.
Solo 401(k) are designed for businesses with no employees other than the owner and their spouse. Businesses with one or more employees need to have a multi-participant 401(k) instead which means potential requirements to contribute to your employees’ accounts.
However, there are some exceptions to those rules. For instance, you can still contribute to a plan if your spouse works for the business part or full-time. You can also exclude certain employees like those under 21 or part-time employees who haven’t completed 1,000 hours of work during a 12-month period.
Who’s the ideal candidate for a solo 401(k)?
A solo 401(k) is a great retirement plan option for a one-person business if:
- You want to make significant, deductible contributions and have the funds to do so
- You have solid net self-employment income
- You’re 50 or older and can take advantage of the catch-up contribution
Before jumping into a solo 401(k), it’s important to consider other retirement options, especially if you’re 50 or older. While solo 401(k)s offer the benefit of high, tax-deductible contributions, they do come with added complexity. Get in touch with your Smolin advisor to find the best solution for building your retirement nest egg.