Solo 401(k): Guide to Self-Employed Retirement Plans

When people talk about 401(k)s and retirement plans, they’re usually talking about employer-sponsored plans. But how can you plan for retirement if you’re self-employed?

Luckily, you have options if you’re self-employed and want to save for retirement. There are a handful of self-employed retirement plans you can contribute to — including a solo 401(k).

Are you ready to start planning for your financial future? Learn more about starting a self-employed 401(k) — including how much you can contribute and how withdrawals work.

Can self-employed people have a 401(k)?

Freelancers, solopreneurs, and independent contractors can start a solo 401(k), which is simply a 401(k) for self-employed individuals. The key difference here is that you don’t have an employer to match your 401(k) contributions, so you’re solely responsible for building up your savings.

Traditional employer 401(k)s are subject to nondiscrimination testing while your self-employed 401(k) isn’t. These tests are usually conducted annually to make sure everyone benefits equally from 401(k) plans.

A solo 401(k) isn’t your only option if you’re self-employed. There are several other types of plans you can qualify for, including:

• Simplified Employee Pension (SEP): Once you complete Form 5305-SEP, you can open a SEP-IRA through a bank and start contributing to your retirement plan.
• SIMPLE IRA: You can set up a SIMPLE IRA between January 1 and October 1, allowing you to contribute your net earnings from self-employment to save for retirement.

You can also set up a Roth IRA or an IRA as a self-employed individual. If you decide to save for retirement with an IRA, make sure you’re investing the money you’re contributing.

Keep in mind that you can be your own plan administrator with a solo 401(k), which saves you money but gives you more responsibilities. If you want to start a 401(k) and you’re self-employed, you may want to consider a third-party administrator.

How to set up and manage a solo 401(k)

Setting up a solo 401(k) is fairly straightforward, but there are several steps involved. Let’s walk through each step to help you get started.

First, you need to determine if you’re eligible for a solo 401(k). A solo 401(k) is meant to cover business owners with no employees besides yourself. A solo 401(k) may also cover your spouse.

Next, choose a provider for your solo 401(k). There are lots of providers to choose from, so research and compare providers to make the right choice based on your needs. Consider cost, investment diversification, and your contribution options.

If you don’t want to act as the plan administrator, some financial institutions may offer plan administration services for a fee. Having a third-party administrator means you don’t have to focus on record-keeping and other tedious tasks.

Now that you’ve found a provider, you need to make sure you have all the necessary documents and information to set up a solo 401(k). Here’s what you’ll need:

• Personal information: You need to verify your identity to start a 401(k), so have your personal information and your driver’s license or passport handy. 
• Employer identification number (EIN): Your EIN is essentially a Social Security number for your business, serving as a unique identifier for self-employed taxes. If you lost your EIN, you should be able to find it on your confirmation letter or other business documents. You can also call the IRS Business & Specialty Tax Line at (800) 829-4933.
• Beneficiary information: In the event that you pass, you need to name a beneficiary for your solo 401(k). You don’t have to add a beneficiary when you open your solo 401(k) — you can do it later.
• Bank account information: Last but not least, you need to connect a bank account for withdrawals and contributions.

The next step is opening your solo 401(k). This involves filling out an application and paying the annual fee (if applicable). Once you receive a written agreement, you can sign it to start your 401(k).

If you have an existing plan, you’ll need to resign from your current provider before moving to a self-directed 401(k).

Funding your 401(k) is as simple as making contributions from the bank account you connected. If you have a third-party plan administrator through a financial institution, you don’t have to worry about keeping records.

Tax benefits of self-employed 401(k) plans

Self-employed 401(k) plans are a great way to save for retirement, but they also offer tax benefits. Let’s take a look at the connection between 401(k) savings and your taxes.

The contributions you make to your 401(k) plan are made with pre-tax dollars, which helps you contribute more since you don’t have to pay taxes beforehand. You can also deduct contributions you made from your personal income, reducing the amount you owe in federal taxes.

To figure out your allowable contribution rate and tax deduction, use the worksheets in Chapter 5 of IRS Publication 560, Retirement Plans for Small Business.

Starting a solo 401(k) won’t stop you from opening IRAs and other retirement accounts. If you want to contribute the annual maximum to an IRA and your self-employed 401(k), you can do that.

Potential drawbacks self-employed 401(k) plans

Contributing to a solo 401(k) plan can be a smart move if you can afford it, but there are some potential drawbacks. Let’s look at some of the downsides before you start a solo 401(k).

Making regular contributions to a solo 401(k) reduces your monthly income, which can be an issue if you’re struggling financially. You may want to consider how much you can contribute before starting a 401(k).

If you’re acting as the plan administrator, you have more responsibilities than you’d have with an employer-sponsored 401(k). You’re responsible for managing contributions and distributions, record-keeping, and more.

You may want to consider another type of retirement plan if you can’t contribute the maximum amount each year. IRAs have much lower contribution limits than 401(k) plans, and you can choose between a Roth or traditional IRA.

If you’re planning on expanding your business by staffing employees in the near future, self-employed 401(k)s likely won’t be the right option.

Weighing the pros and cons can help you decide what type of self-employed retirement plan is right for you.

Solo 401(k) contribution limits for 2023 and 2024

Whether you’re contributing to a solo 401(k) or an employer-sponsored plan, you can only contribute a certain amount annually. Here’s what you need to know about the solo 401(k) contribution limits for 2023 and 2024.

The self-employed 401(k) contribution limits are $23,000 in 2024 and $22,500 in 2023. This is the amount you can contribute in elective deferrals, up to 100% of your earned income as a self-employed individual.

Nonelective contributions are calculated differently for self-employed individuals. You need to start by figuring out your earned income, which is your net earnings after deducting:

• Half of your self-employment tax
• Contributions for yourself

Note that you can make additional contributions to an IRA while contributing to a solo 401(k). If you’re able to comfortably contribute your limit each year, consider starting a traditional or Roth IRA to save more.

Rules for withdrawing funds from your solo 401(k)

Withdrawing from your solo 401(k) is similar to withdrawing from any 401(k) plan. You can’t withdraw money until you reach the age of 59½, and any withdrawals you make before that age will incur a 10% tax penalty unless you meet an exception.

There are no penalties for withdrawing money from your solo 401(k) after you’ve turned 59½, but it’s important to consider the tax implications. Solo 401(k) withdrawals are taxed as ordinary income during the tax year that those withdrawals were made.

When you turn 73, you must start taking the required minimum distributions (RMDs) from your solo 401(k) account. Penalties may apply if you don’t take RMDs when you turn 73.

Self-employed 401(k) vs. other retirement plans

Self-employed 401(k) plans aren’t the only option for self-employed retirement planners.

You can start a traditional or Roth IRA and contribute up to $7,000 in 2024 ($8,000 if you’re age 50 or older), up from $6,500 and $7,000 respectively in 2023. IRAs can also exist alongside your solo 401(k).

There are a few other types of retirement plans you can start when you’re self-employed. SEP plans are easy to start through a bank or financial institution, or you can start a Savings Incentive Match Plan for Employees (SIMPLE IRA plan).

Each retirement plan offers different contribution limits, withdrawal rules, and tax benefits. You can talk to a financial advisor or tax expert to learn more about planning for retirement and how it affects your taxes.

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