Maximizing Retirement Savings Using the Solo 401(k) for Self-Employed Business Owners

Attention, self-employed entrepreneurs! Are you pondering the optimal path to secure your retirement? Look no further than the Solo 401(k), your personalized retirement solution. Tailored for small-business trailblazers without full-time W-2 employees—except, perhaps, your spouse—this plan offers a turbocharged avenue to bolster your retirement savings. Perfect for sole proprietors, independent consultants, LLCs, partnerships, and owner-only S-corporations or C-corporations, the Solo 401(k) mirrors the robust retirement plans of larger corporations, ensuring your financial future shines as brightly as your entrepreneurial spirit. Let’s delve into how a Solo 401(k) can work wonders for your retirement future.

How Does a Solo 401(k) Work?

The Solo 401(k) functions much like a traditional 401(k) offered through many larger employers. As the employer, you contribute both as the employee and the employer from your earnings. These contributions can then be invested to grow tax-deferred until retirement. Solo 401(k) accounts are popular because they can offer tax-deferred and tax-free income in retirement. They are a great tool to help high-income earners save aggressively, benefit from tax deductions, and shelter growth from taxes while funds remain inside these retirement accounts.

What Are the Solo 401(k) Contribution Limits?

The standout feature of the Solo 401(k) is its dual contribution approach which allows you to make both employer and employee contributions. As of 2024, you can contribute up to $23,000 or 100% of your compensation (whichever is less) as an employee. If you're 50 or older, you can add another $7,500 in catch-up contributions annually. Additionally, as the employer, you can contribute up to 25% of your compensation per year for a total annual maximum of $69,000 or $76,500 if you age 50 and over.

Can My Spouse Participate in My Solo 401(k) Plan?

If your spouse also works for the business, you both can participate in the same Solo 401(k) plan. This offers a massive opportunity to potentially double the contributions for your household.

When Do I Have to Offer a 401(k) Plan To Part-Time Employees?

If you have part-time employees who work between 500-1000 hours per year in your business for three consecutive years, they will need to be offered the opportunity to participate in your 401(k) plan. Therefore, it is important that you track your employees’ hours for eligibility requirements so you know when you would need to switch to another plan.

What Are The Contribution Types With A Solo 401(k) Contribution?

Employee contributions may be applied as pretax, Roth, or as a voluntary after-tax contribution. Employer contributions can be applied as pretax or as a Roth contribution after the SECURE Act 2.0. The voluntary after-tax contributions, much like Roth contributions contributed on an after-tax basis, apply to help reach the overall limit category. This is how you would facilitate the “Mega Backdoor Roth” contribution strategy.

What Is Involved In Setting Up A Solo 401(k) Plan?

You can establish a Solo 401(k) through a financial institution that administers 401(k) plans. Since these plans usually involve only one or two individuals, they're simpler to administer than standard 401(k)s. This simplicity often translates to lower fees. Owner-only employers can establish a Solo 401(k) by their business tax return due date plus business extensions.

What Is Involved In Managing A Solo 401(k) Plan?

Once set up, you maintain control and freedom of choice over the investment selections within your plan. There's no annual minimum contribution requirement, allowing flexibility based on your business's financial performance. Only once the plan assets exceed $250,000 must you then file Form 5500-EZ with the IRS. A 1099-R is filed with the IRS any time a distribution is made such as annual Required Minimum Distributions (which start at age 72 depending on your year of birth), in-plan Roth conversions, and plan termination.

What Are The Solo 401(k) Withdrawal Requirements?

Like standard 401(k) plans, Solo 401(k)s aim to facilitate retirement savings. Regulations govern withdrawals, including early withdrawal penalties and required minimum distributions starting at age 72.

Sample Scenario

Amelia, age 44, owns a digital marketing firm as a self-employed business owner and is taxed as an S-Corporation. Her goal is to maximize her pre-tax contributions and then make Roth Solo 401(k) and voluntary after-tax contributions. She made $100,000 in W-2 wages from the business. Amelia is eligible to contribute a total of $69,000:

$23,000 as the employee in 2024

$25,000 as the employer pre-tax contribution (25% of W-2 wages $100,000 X 0.25 subject to the overall contributions cap), and

$21,000 as a voluntary after-tax contribution ($69,000 annual limit - $23,000 - $25,000).

With high contribution limits, flexible investments, significant tax-sheltered retirement savings, and straightforward administration, the Solo 401(k) is a powerful retirement choice for self-employed individuals. If you plan to remain a one-person operation, this option can help you save aggressively for retirement. Take charge of your financial future today with a Solo 401(K).