A Solo 401(k), also known as a one-participant 401(k) or self-employed 401(k), is a retirement savings plan specifically designed for self-employed individuals or small business owners who have no full-time employees other than themselves and potentially their spouse.
Key Features
Contribution Limits
Solo 401(k) plans allow higher contribution limits compared to traditional and Roth IRAs:
Employee Contributions: As an employee, you can contribute up to 100% of your earned income, up to an annual maximum of $22,500 in 2023 (or $30,000 if you are age 50 or older and making catch-up contributions).
Employer Contributions: As the employer, you can contribute up to 25% of your net self-employment income.
Total Contributions: The total contributions (employee and employer combined) can be up to $66,000 for 2023 (or $73,500 if including catch-up contributions).
Tax Benefits
- Tax-Deferred Growth: Contributions grow tax-deferred until withdrawal.
- Roth Option: Some Solo 401(k) plans offer a Roth option, allowing post-tax contributions with tax-free withdrawals in retirement.
Roth Solo 401(k)
The Roth variant allows for after-tax contributions, resulting in tax-free growth and tax-free withdrawals in retirement.
Eligibility
Who Can Participate?
- Self-employed individuals with no employees or full-time employees other than a spouse.
- Independent contractors and freelancers.
Business Structures
- Sole proprietors
- Partnerships
- LLCs
- Corporations (S-corporations and C-corporations)
Special Considerations
Loans and Withdrawals
- You may borrow up to 50% of your account balance, not to exceed $50,000.
- Withdrawals before age 59½ may incur a 10% early withdrawal penalty in addition to regular income tax.
Reporting Requirements
- Form 5500-EZ: Necessary if the plan’s assets exceed $250,000.
Examples
Case Study: Solo 401(k) for a Consultant
Jane doe, a 45-year-old independent consultant, decides to open a Solo 401(k). Her net self-employment income is $100,000. She contributes:
- Employee Contribution: $22,500
- Employer Contribution: $18,587.50 ($100,000 * 25% of earned income)
Making a total contribution of $41,087.50 for the year.
Historical Context
The Solo 401(k) was developed following the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), aimed at providing business owners and self-employed individuals with retirement savings options comparable to those available for larger businesses.
Comparisons
Solo 401(k) vs. SEP-IRA
- Contribution Limits: Solo 401(k) often allows higher contributions.
- Roth Option: SEP-IRAs do not offer a Roth option.
- Loans: Solo 401(k) plans may allow loans, SEP-IRAs do not.
Related Terms
- SEP-IRA: A Simplified Employee Pension plan, another retirement option for self-employed individuals.
- Traditional IRA: A retirement account allowing pre-tax contributions and tax-deferred growth.
- Roth IRA: A retirement savings account allowing for post-tax contributions and tax-free withdrawals.
FAQs
Can I open a Solo 401(k) if I have employees?
What is the main advantage of a Solo 401(k)?
Can my spouse participate in my Solo 401(k)?
Can I still contribute to an IRA if I have a Solo 401(k)?
References
- IRS.gov - Retirement Plans for Self-Employed People
- Fidelity - Solo 401(k) Plan
- Economic Growth and Tax Relief Reconciliation Act of 2001
Summary
The Solo 401(k) is a powerful retirement savings tool for self-employed individuals and small business owners without full-time employees. It offers substantial contribution limits, tax benefits, and the flexibility to make both employee and employer contributions. Understanding the nuances and regulations of Solo 401(k) can help self-employed individuals maximize their retirement savings and benefit from tax-advantaged growth.
