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As of 2023, 27.1 million US businesses were businesses with no employees.[1] Owners of businesses have options to save for retirement with Traditional and Roth IRAs. But these types of individual accounts have significantly lower contribution limits than employer sponsored retirement plans like 401(k)s, 403(b)s, 457 plans, or even SIMPLE IRAs or Simple 401(k), which may leave many small business owners with a lack of income at retirement. Solo 401(k) plans allow owners who are the only employee to save as much as if they were working for an outside employer rather than themselves. [2],[3]

Key aspects of solo 401(k) plans:

  • The employee portion of the contributions is either pre- or post-tax. As a single-person 401(k) plan, the owner can set up the plan with their tax needs in mind. With a Traditional solo 401(k), they could lower their tax burden in the present with pre-tax contributions but pay taxes when they withdraw the money later. And with the Roth version, they would face no taxes at distribution but pay taxes on the income in the present.
  • The Solo 401(k) Profit Sharing Contributions or the Employer Contributions can only be made as pre-tax contributions. 2,3,[4]
Updated For 2024: As an employee, yearly contribution limits are $23,000 for people younger than 50 and an extra $7,500 catch-up for those 50 and older in 2024. Since the person in the plan is also the employer, they can make a match contribution of the same $23,000 for people younger than 50 and an extra $7,500 catch-up for those 50 and older. The combined contribution cannot exceed $69,000 for those younger than 50 and $76,500 for those 50 and older. Employer contributions cannot exceed 25% of the employee’s income. 3,4,[5],[6],[7]

  • Contributions can be made until the tax filing deadline for that tax year (April 15th or October 15th if you file for an extension). However, the plan must be established before the end of a calendar year to contribute to that year. 3
Unique to Solo 401(k) plans: Owners can allow their spouses to participate in the plan if they earn income from the business. 3

  • Investment options include individual stocks, mutual funds, ETFs, annuities, UITs, etc. Investment vehicles are prohibited in solo 401(k)s, including antiques/collectibles (artwork, gems, wines, etc.) and most coins. [8]
  • With all investment accounts, you expose some or all your invested money to loss for the chance to earn a higher profit. Investment gains hinge on an ongoing and long-term investment strategy that uses your risk tolerance and diversification to mitigate some risks. Even with these in place, you are exposing your money to loss.[9]
  • The earliest you can take penalty-free withdrawals is 59 ½; the penalty is an extra 10% on top of the taxes collected. However, there are some exemptions to the early withdrawal penalty- if you are permanently and totally disabled, if you lose your job at 55 or older, if you have medical expenses that exceed 10% of your modified adjusted gross income, with some divorce settlement types and if you die.2
Secure Act 2.0 Change: Required Minimum Distributions (RDMs) need to start at 70 1/2 if you were born before 7/1/49; 72 if you were born on or after 7/1/49 or in 1950; 73 if born between 1951 and 1958; 75 if born in 1960 or later. If you were born in 1959, federal guidance is needed to determine if your Required Beginning Date is age 73 or 75, but you can still contribute to this type of plan if you are still employed. With some plans, that contribution offsets the RMDs.[10],[11]
  • As the only participant within the fund, you can build a plan that allows both hardship withdrawals and loans.[12]
  • Solo 401(k) plans are not required to perform nondiscrimination tests (NDTs) because they are only allowed for a business without employees, and therefore, there is no fairness standard to check. 2
  • Fees vary from plan to plan. It is crucial to understand how much you are paying in fees.
  • If you structure it into your plan, you can accept rollovers from other retirement accounts, including SEP IRAs and traditional 401(k)s. You can roll over your solo 401(k) assets into another 401(k) or an IRA. Like with all retirement accounts, only if the new accounts match the tax designation of the original account- pre-tax account to pre-tax account and post-tax to post-tax. 2
  • Suppose the business owner also works at a job that offers an employer sponsored retirement plan (as an example- they sold freelance artwork while maintaining outside employment). In that case, their employee contributions combine for each account to reach the limit of $23,000 for people younger than 50 and an extra $7,500 catch-up amount for those 50 and older.[13],[14],[15]
  • You can take a low-interest loan on Solo 401(k) accounts, up to $50,000 or 50% of your account balance. The loan is for a 5-year maximum term. The period can be extended if the loan is used to purchase a primary residence. Some plans don’t let you contribute to your account until the loan is paid back. Interest charges go directly back into your retirement account. If you fail to repay the loan, it is considered a distribution and taxed accordingly, including early distribution penalties if applicable based on your age.6

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Sources:

[1] https://www.forbes.com/advisor/business/small-business-statistics/#:~:text=Yet%2C%20despite%20the%20fact%20that,businesses%20employ%2061.7%20million%20workers.

[2] https://www.fidelity.com/learning-center/personal-finance/retirement/self-employed-401k

[3] https://www.nerdwallet.com/article/investing/what-is-a-solo-401k

[4] https://www.irafinancialgroup.com/learn-more/solo-401k/2022-solo-401k-contribution-limit-changes/

[5] https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/2023-irs-401k-contribution-limits.aspx

[6] https://www.irs.gov/newsroom/401k-limit-increases-to-23000-for-2024-ira-limit-rises-to-7000

[7] https://fitaxguy.com/2024-solo-401k-update/

[8] https://royallegalsolutions.com/prohibited-solo-401k-investments-what-you-cant-invest-in-with-a-solo-401k

[9] https://www.investor.gov/sites/investorgov/files/2019-02/Saving-and-Investing.pdf

[10] https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-required-minimum-distributions-rmd

[11] https://www.tiaa.org/public/support/faqs/required-minimum-distributions

[12] https://ira123.com/solo-401k-loan/

[13] https://finance.zacks.com/can-contribute-401k-simple-ira-same-year-2907.html

[14] https://www.whitecoatinvestor.com/multiple-401k-rules/

https://www.kiplinger.com/article/retirement/t047-c001-s001-saving-for-retirement-when-you-have-a-side-hustle.html

[15] https://www.irs.gov/newsroom/401k-limit-increases-to-22500-for-2023-ira-limit-rises-to-6500#:~:text=Highlights%20of%20changes%20for%202023,to%20%246%2C500%2C%20up%20from%20%246%2C000.

This material has been prepared for informational purposes To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Each taxpayer should seek independent advice from a tax professional based on individual circumstances.