For small business owners with no employees (except a spouse) looking to establish a retirement plan, a solo 401(k) is worth considering. This option is also suitable for self-employed individuals or business owners wanting to upgrade from a SIMPLE IRA or SEP plan.
A solo 401(k), also called an individual 401(k), may offer benefits in contributions, tax savings, and investment choices. These accounts are designed for self-employed people, including sole proprietors, single-member LLC owners, consultants, and other one-person businesses.
What are the contribution limits of a solo 401(k)?
Solo 401(k) plans allow for substantial annual tax-deductible contributions. In 2024, you can make an “elective deferral contribution” of up to $23,000 of your net self-employment (SE) income. This limit increases to $30,500 if you’ll be 50 or older by December 31, 2024. The higher $30,500 figure includes an extra $7,500 catch-up contribution for older owners.
In addition to your elective deferral, you can make an “employer contribution” of up to 20% of your net SE income. Despite the name, there’s no actual employer when you’re self-employed. When calculating this contribution, your net SE income isn’t reduced by your elective deferral.
For the 2024 tax year, the combined elective deferral and employer contributions can’t exceed:
- $69,000 ($76,500 if you’ll be 50 or older by December 31, 2024), or
- 100% of your net SE income.
Net SE income is the net profit shown on Form 1040, Schedule C, E or F for the business, minus the deduction for 50% of self-employment tax linked to the business.
What are the pros and cons?
Beyond the ability to make significant deductible contributions, solo 401(k)s offer flexibility. If money is tight, you can contribute less or nothing at all.
Another advantage is the ability to borrow from your solo 401(k) account, if the plan allows it. You can borrow up to 50% of the account balance or $50,000, whichever is less. Some other plans, like SEPs, don’t offer loans. This feature can be helpful if you need funds for business opportunities or emergencies.
The main drawback of solo 401(k)s is their complex management. They require substantial initial paperwork and ongoing administration, including a written plan document and a system for collecting and depositing elective deferrals. Additionally, when your account exceeds $250,000, you must file Form 5500-EZ with the IRS yearly.
Solo 401(k)s are only for businesses without employees. If you have staff, you’ll need a multi-participant 401(k), which can be more complicated and may require employee contributions. However, there are exceptions. You can contribute if your spouse is an employee, and you can exclude workers under 21 or part-timers who haven’t worked 1,000 hours in any 12-month period.
Who should consider this plan?
A solo 401(k) might be a good fit for a one-person business if:
- You want to make large yearly tax-deductible contributions and have the funds,
- Your net SE income is significant, and
- You’re 50 or older and can benefit from the extra catch-up contribution.
Before choosing a solo 401(k), consider other retirement plans, especially if you’re 50 or older. While solo 401(k)s aren’t straightforward, they can allow for substantial, tax-deductible retirement savings. It’s wise to consult with us or one of our Landmark Financial advisors before making a decision to ensure it’s the best choice for your situation.
© 2022. Updated November 2024.