What Is a Solo 401(k) and Should You Have One?

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A Solo 401(k) is called many different things — a personal 401(k), individual 401(k), self-employed 401(k), Solo-k or Uni-k. No matter the name, they all translate into retirement savings plans for small business owners who don’t have employees except for a spouse. Many types of 401(k) plans are available, but if you’re a sole proprietor or independent contractor, and you want a savings plan like those offered by a big company, this might be the right choice for you.

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You can build a sizable nest egg with a Solo 401(k), just like you can with a plan at a large business. For example, say Mary, a 30-year-old, socks away $10,000 a year in her Solo 401(k) and gets a 6% annual return on her money. By the time she’s 65, she will have contributed $350,000 to the plan, and her account will have grown to almost $1.2 million.

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Given the fact that so many Americans are retiring broke today, it’s crucial that, as a sole proprietor, you save for retirement now. Then you won’t be left out in the cold when it comes time to quit your 9 to 5. Keep reading to see whether you should open one today.

What Is a Solo 401(k)?

A Solo 401(k) is a savings-maximizing retirement plan for self-employed individuals or those who are partners in businesses whose employees consist only of those partners and their spouses. You cannot contribute to this plan if you have any common-law employees. According to the IRS, “anyone who performs services for you is your employee if you can control what will be done and how it will be done.” The business owner can, however, contribute to the Solo 401(k) as both an employer and an employee.

Use this handy table to familiarize yourself with Solo 401(k) highlights:

How To Open a Solo 401(k) Get an employer ID number and open at any of a variety of online brokers.
Eligibility Must be a business owner with no employees.
Contributions Limit For 2022, up to $61,000; catch-up contribution of $6,500 for those 50 and older
Contributions Taxes Pre-tax contributions for traditional 401(k); after-tax dollars for Roth 401(k)
Qualified Retirement Distribution Taxes Qualified distributions for 401(k) taxes as income; Roth 401(k) distributions are tax-free
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Solo 401(k) Contribution Limits

Employers can contribute up to 25% of their net self-employment compensation (up to $61,000 in 2022) to a Solo 401(k), and those contributions are typically tax-deductible as a business expense. When an employee makes contributions, it’s important to remember that all participants must get the same percentage. Contributions are generally deductible as a business expense and aren’t required every year. When contributions are made, however, all participants must receive the same percentage.

Employees can make contributions either pre-tax or through a Roth plan, which offers after-tax contributions. Employees can contribute 100% of their compensation (up to $20,500 in 2022 or $27,000 if they are 50 or older). You can contribute both as an employer and an employee to a Solo 401(k), but the combined contributions can’t exceed $61,000 for the 2022 tax year ($67,500 if you’re 50 or older).

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Being able to contribute two ways to a Solo 401(k) can add up to significant savings. For example, in 2022, you can make contributions of up to $$20,500. And if you’re at least 50 years old, you can add an extra $6,500 in catch-up contributions annually. As an employer, you can make combined contributions of up to $61,000 in 2022. But if you’re over 50, your combined employee/employer yearly contributions can’t exceed $67,500.

So, for instance, say you’re a business owner with no employees and you made $100,000 in 2022. You could contribute $20,500 as an employee and $25,000 as an employer (based on your total salary minus self-employment taxes and business expenses). That means that each year, you could save a whopping $45,500.

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Solo 401(k) Withdrawal Rules

Solo 401(k) rules dictate that you cannot make any withdrawals until a specified event occurs. These events include reaching age 59 1/2, separation from service, termination of the plan or something else the plan identifies. You might be able, however, to make a hardship withdrawal, but you’ll pay a 10% penalty if you haven’t reached the age of 59 1/2. Solo 401(k) sponsors are not required to offer loan provisions within plans. Check with your plan’s sponsor to confirm.

You generally have to start taking withdrawals from your Solo 401(k) by April 1 in the year after you turn 72. You can structure your plan to accept other retirement account rollovers, such as SEP-IRAs and traditional IRAs.

Tax Benefits of Solo 401(k)s

A Solo 401(k) offers account holders the opportunity to choose their own tax advantages. You can either open a pre-tax account — aka traditional Solo 401(k) — or an after-tax account, known as a Roth Solo 401(k). If you choose the former, your retirement distributions will be taxed as regular income, but if you choose the latter, your retirement distributions will be tax-free.

You can access additional tax breaks with your Solo 401(k). For example, if your business isn’t incorporated, you can typically deduct your contributions for yourself from your personal compensation. In the case of incorporation, however, your contributions can be considered a business expense.

Solo 401(k) vs. SEP IRA

You might be on the fence about which type of account to open, a Solo 401(k) or a Simplified Employee Pension IRA. In that case, reference this chart to see which retirement account option is better for your situation:

SEP IRA Solo 401(k)
Advantages Best for business owners who want to provide retirement benefits to all employees by making contributions Can contribute as employer and employee
Which Employers Can Provide Plan People who are self-employed or businesses that don’t have retirement plans Self-employed individuals with no common-law employees
Employee Eligibility To join, employees typically must be 21 or older and earn at least $650 during the tax year. No employees allowed; no age restriction
Funding Employers only contribute; employees can’t contribute via payroll deductions but might be able to make traditional IRA contributions. Business owners can contribute as employer and/or employee
Contribution Options Each year, employer can decide if it wants to contribute Business owners can contribute as employer and/or employee
Employer Contribution Limits Maximum of $61,000 for the 2022 tax year; contributions are deductible and not required each year Up to $61,000 for the 2022 tax year ($67,500 if age 50 or older); contributions are deductible and not required each year
Employee Contribution Limits Up to $6,000 ($7,000 for employees 50 and older) Up to $20,500 ($27,000 for employees age 50 or older)
Withdrawals Withdraw at any time, subject to federal income taxes and a possible 10% penalty if the employee is under age 59 1/2 No withdrawals until age 59 1/2 or a specified event; possible hardship withdrawals subject to 10% penalty if under age 59 1/2
Employer’s Responsibility Fill out Form 5305-SEP; no IRS reporting Possible annual filing of Form 5500

How To Open a Solo 401(k)

Once you have an Employer Identification Number, you can set up a Solo 401(k) through any financial institution that administers 401(k)s. Administration fees for Solo 401(k)s are generally lower than other 401(k)s because they are so simple to manage, given a Solo 401(k) involves only one or two people. Some financial institutions don’t even charge for setting up and maintaining these types of accounts.

Before you sign your name on the dotted line, know exactly what fees will apply to your account. In addition, consider going with a plan that offers a lot of different investment types, such as stocks, bonds, mutual funds, CDs and ETFs.

Once you’ve established your plan, decide on how much you’ll contribute and which investments you want. Because there isn’t a minimum contribution requirement annually, you can contribute more in profitable years and contribute less in lean years.

An important reminder: If your account is worth more than $250,000, you must file IRS Form 5500-EZ, the Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan.

Where To Open a Solo 401(k)

If you’re wondering where to open a Solo 401(k), you have lots of options. This table shows six popular choices for Solo 401(k) plans:

Provider Highlights
Vanguard Low-cost Solo 401(k) you can set up easily
ShareBuilder 401(k) All-online plan that features low-cost investments and simple administration
Charles Schwab Access brokerage and banking services in addition to a Solo 401(k)
Fidelity In-person service; large network of offices from which to choose
E-Trade Enables you to actively trade stock and other securities in your retirement account
TD Ameritrade Good account if you want a traditional provider as an alternative to Vanguard

Decide Now If a Solo 401(k) Is Right for You

If you don’t want to retire broke and you’re a sole proprietor with no employees except your spouse, you might really like being able to have complete control of your plan and take immediate action when an investment becomes available. Any contributions you make to a Solo 401(k), as well as investment returns and earnings, are tax-deferred until withdrawal — and employers receive tax benefits too. In addition, you can roll a Solo 401(k) over if you change jobs. It’s always a good idea to check with a financial advisor or tax professional before you make any big financial decisions and opening a Solo 401(k) is no exception.

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Daria Uhlig contributed to the reporting for this article.

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About the Author

Barri Segal has 20+ years of experience in the publishing and advertising industries, writing and editing for all styles, genres, mediums, and audiences. She has been writing on personal finance topics for 12 years and gains great satisfaction from making a difference in consumers’ lives.
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