If you’re self-employed and operate a small business without any employees (other than your spouse), a solo 401(k) plan is a great option for establishing a retirement plan. This plan is also 
suitable for self-employed individuals or business owners looking to upgrade from a SIMPLE IRA or a Simplified Employee Pension (SEP) plan.
A solo 401(k), or individual 401(k), offers benefits in terms of contribution limits, tax savings, and investment choices. It’s specifically for self-employed individuals, such as sole proprietors, owners of single-member limited liability companies, consultants, and other one-person businesses.
Contribution Limits
With a solo 401(k), you can make significant annual tax-deductible contributions. For the tax year 2024, you can contribute up to $23,000 of your net self-employment (SE) income as an “elective deferral contribution.” If you’re 50 or older by December 31, 2024, this limit increases to $30,500, which includes a catch-up contribution of $7,500.
In addition to the elective deferral contribution, you can also make an “employer contribution” of up to 20% of your net SE income. Even though you’re self-employed, your net SE income for this calculation isn’t reduced by your elective deferral contribution.
For 2024, the total combined elective deferral and employer contributions cannot exceed:
- $69,000 ($76,500 if you’re 50 or older by December 31, 2024), or
- 100% of your net SE income.
Net SE income is the net profit on Form 1040, Schedule C, E, or F, minus the deduction for half of the self-employment tax related to the business.
Pros and Cons
A solo 401(k) allows for large deductible contributions, and contributions are discretionary. If cash flow is tight, you can choose to contribute a smaller amount or skip contributions entirely.
Additionally, you may borrow from your solo 401(k) if your plan document allows it, with the maximum loan amount being 50% of your account balance or $50,000, whichever is lower. Other plans, such as SEPs, do not permit loans, making this feature beneficial for accessing funds in emergencies or business opportunities.
However, the main drawback of a solo 401(k) is its administrative complexity. Establishing the plan requires significant paperwork and ongoing administrative work, including adopting a written plan and determining how and when contributions will be made. If your account balance exceeds $250,000, you must file Form 5500-EZ with the IRS annually.
You cannot set up a solo 401(k) if your business has employees, requiring you to switch to a multi-participant 401(k), which brings its own complications. However, you can still contribute to a solo 401(k) if your spouse is a part-time or full-time employee and exclude employees under 21 or part-time employees who have not worked at least 1,000 hours in a 12-month period.
Ideal Candidates for a Solo 401(k)
A solo 401(k) is a smart retirement plan option for solo entrepreneurs if:
- You wish to make large annual deductible contributions and have the financial means to do so,
- You have substantial net SE income, and
- You are 50 or older and can take advantage of the additional catch-up contribution.
Before setting up a solo 401(k), carefully evaluate the pros and cons of other retirement options, particularly if you’re 50 or older. While solo 401(k)s can be complex, they offer significant opportunities for substantial and deductible contributions to your retirement savings. Contact us to discuss your situation and find the best retirement plan for you.
