How Self-Employed Individuals Can Build a Robust Retirement Nest Egg with a Solo 401(k)

For self-employed individuals or small business owners with no employees (other than a spouse), a solo 401(k) plan can be a powerful tool for building retirement savings. This plan, also known as an individual 401(k), offers higher contribution limits, potential tax savings, and a range of investment options. It’s particularly suitable for sole proprietors, single-member LLC owners, consultants, and other one-person businesses, as well as those looking to upgrade from a SIMPLE IRA or SEP plan.

Contribution Limits for 2024

A solo 401(k) allows substantial, tax-deductible contributions. In 2024, you can make an “elective deferral contribution” of up to $23,000 of your net self-employment income. This limit increases to $30,500 if you are age 50 or older by December 31, 2024, thanks to a $7,500 catch-up contribution.

In addition to the elective deferral, solo 401(k) participants can make an “employer contribution” of up to 20% of net self-employment income. For 2024, the total combined contribution (elective deferral plus employer contribution) cannot exceed:

- $69,000 (or $76,500 if you’re 50 or older), or

- 100% of your net self-employment income.

Your net self-employment income is calculated as your business’s net profit, reduced by 50% of the self-employment tax deduction.

Key Benefits and Drawbacks

The solo 401(k) allows large deductible contributions, with flexibility to adjust contributions if cash flow is limited. Another advantage is the option to borrow from your solo 401(k) if your plan document permits it, with a maximum loan of up to 50% of the account balance or $50,000, whichever is less—a benefit unavailable in SEP plans.

However, solo 401(k) plans require more administrative effort than other retirement plans. Setting up the plan involves paperwork and ongoing compliance, including filing IRS Form 5500-EZ annually once the account exceeds $250,000. Additionally, solo 401(k)s are limited to businesses with no employees; however, part-time employees under age 21 who work fewer than 1,000 hours in a year are exempt from plan participation requirements, as is your spouse if they work for your business.

Is a Solo 401(k) Right for You?

A solo 401(k) may be an ideal fit if you’re a one-person business owner with significant self-employment income, a desire to make large deductible contributions, and are age 50 or older. Before choosing this plan, consider other retirement options to determine the best fit for your needs. Contact us to evaluate your situation and help you select the most effective retirement strategy.