What is a solo 401(k) plan and how does it work?

Working for yourself can be rewarding. After all, self-employment may offer more freedom and flexibility than a traditional job. But it doesn’t offer the same employer-sponsored benefits, like retirement plans, you might expect from a larger company. 

Wondering how to juggle self-employment and saving for the future? Investment accounts—like a solo 401(k)—are designed to help self-employed people save for retirement. 

Find out what a solo 401(k) is, how it works and who is eligible to use one.  

Key takeaways

• A self-employed person can contribute to their solo 401(k) plan as both the employee and the employer.
• Traditional solo 401(k)s are funded with pre-tax contributions and have taxable withdrawals.
• Roth solo 401(k) contributions are made with after-tax dollars. Qualified withdrawals are tax-free.
• Solo 401(k) participants could invest up to 100% of their self-employed income until they reach the contribution limit.

A solo 401(k) is a retirement savings account that’s designed for self-employed individuals. This retirement plan offers many of the same benefits you might see with a company-sponsored 401(k).

For example, both plans allow participants to fund accounts with pre-tax dollars. And contributions can grow tax-free until the account holder withdraws their investments during retirement. But there are some key differences between these two account types. 

A solo 401(k)—sometimes called a one-participant 401(k)—may have higher contribution limits. And unlike a company-sponsored 401(k), solo 401(k)s don’t have potential age restrictions or income limits. Keep in mind, though, that self-employed workers must meet certain requirements to qualify. 

How to qualify for a solo 401(k)

To qualify for a solo 401(k), a person:

• Must be a self-employed worker
• Can’t have employees other than their spouse
• Must have an employer identification number (EIN) issued by the IRS

Interested in opening a solo 401(k) but unsure if you qualify? It might be a good idea to discuss your self-employment situation with a professional tax adviser. You could also contact a company that offers solo 401(k)s, or other retirement planning services, to explore your options. 

According to the IRS, a self-employed worker can contribute to their solo 401(k) as both an employer and an employee. As a result, solo 401(k)s may have higher contribution limits than employer-sponsored 401(k)s. 

Having the ability to save more money could help self-employed workers reach their financial goals and grow their retirement nest eggs. These higher contribution limits could offer some unique tax benefits, too. 

Here’s a breakdown of solo 401(k) contribution limits:

Employee contribution limit

In 2022, a person with a solo 401(k) can contribute up to 100% of their earned income until they reach a yearly maximum of $20,500. Those over 50 can save an additional $6,500 for a yearly contribution limit of $27,000. 

The employee contribution limit will increase to $22,500 for the 2023 tax year. And employees age 50 and over will have an additional catch-up contribution limit of $7,500. 

Employer contribution limit

A self-employed person can also make employer contributions to their solo 401(k). They may be able to contribute up to 25% of their self-employment income, which could help reduce some of their business taxes. 

Solo 401(k)s have a combined contribution limit of $61,000 for 2022. In 2023, the total limit for employee and employer contributions will increase to $66,000. Those who are 50 or older can currently make an additional catch-up contribution of $6,500. In 2023, this catch-up contribution will increase to $7,500. 

Spouse contributions for solo 401(k)

If a self-employed worker’s spouse is also employed by the business, they can contribute to the solo 401(k). This is the only employee exception for this type of 401(k) account.  

Spouses who earn income from the business have the same employee contribution limits as the business owner. And the business owner can also make employer contributions on their spouse’s behalf. 

These higher limits could increase the amount of money a self-employed couple can invest in their solo 401(k). For example, a qualifying couple could potentially contribute up to $114,000 each year to their account. 

Figuring out how much to contribute to a solo 401(k) 

There are many factors to consider when deciding how much to contribute to a solo 401(k). In addition to yearly contribution limits, you might want to factor in the following:

• Estimated annual income
• Monthly cash flow
• Target retirement age
• Retirement savings goal
• Potential tax benefits of contributions

Not sure what your retirement savings target should be? Using an online retirement calculator to determine a savings estimate could be a good place to start. 

It could also be helpful to consult a financial adviser. They can review your current finances and discuss your long-term financial goals. An adviser can use this information to help create an investment strategy that’s tailored to your needs. 

A solo 401(k) may offer self-employed workers some tax advantages that other retirement accounts might not have. With this type of account, self-employed workers also have the flexibility to choose either a traditional solo 401(k) or a Roth solo 401(k). And each of these account types could offer unique tax benefits. 

Traditional solo 401(k)

Since traditional solo 401(k) contributions are made with pre-tax earnings, an account holder could offset some of their taxable income. The funds in this account can grow tax deferred until they are withdrawn during retirement. But keep in mind that the account holder could face certain taxes and penalties for withdrawing solo 401(k) funds before they reach age 59½. 

Roth solo 401(k)

Because a Roth solo 401(k) is funded with after-tax contributions, it doesn’t offer an initial tax break. However, this account does have two potential tax advantages:

• Account investments experience tax-free growth. 
• Qualifying withdrawals won’t be taxed during retirement. 

As with the traditional solo 401(k), any withdrawals the account holder makes before age 59½ may be subject to taxes and penalties.

Tax benefits for business owners

Self-employed business owners may be able to deduct solo 401(k) contributions for up to 25% of their earned income. But keep in mind that the eligible income limit is for the first $305,000 in the 2022 tax year. In 2023, the income limit will increase to $330,000. 

If you want to open a solo 401(k), there are a few steps you might need to take: 

Step 1: Check your options

Consulting a tax adviser ahead of time could be a good way to explore your options. They can review your business situation and help you find which self-employed retirement plans you may qualify for. 

Step 2: Get an EIN

In order to open a solo 401(k), you’ll need your Employer Identification Number (EIN). If you don’t have an EIN, you might be able to submit an online application to the IRS. 

Step 3: Find a plan administrator

Once you understand your options and have the necessary information, you can look for a financial institution that offers self-employed retirement plans—like solo 401(k)s. As you shop for a plan, it’s helpful to review the fees and investment options that each account offers. 

Some plans may let you select a combination of investments that include bonds, stocks, mutual funds and more. It could be a good idea to see if the plan offers any support options, such as online planning tools, service hotlines and mobile apps. 

Step 4: Select a plan

If you qualify for a solo 401(k), you may be able to open either a traditional or Roth account. A tax adviser and plan administrator can help you find the option that’s right for you. Once you find the right plan, you can work with your financial institution to open the account and set up contributions. 

Step 5: Make contributions

It’s important for those with solo 401(k) accounts to comply with IRS employee and employer contribution deadlines. For example, if a self-employed person wants to make a contribution within a specific tax year, they would need to open an account by December 31 of that year. But qualifying employer contributions—like profit-sharing contributions—can generally be made until the tax-filing deadline.

Once the account is open, it might be a good idea to schedule a consultation with the retirement plan’s adviser. They can help account holders monitor their progress and adjust investment strategies to support the account holder’s financial goals. A robo advisor could help track retirement savings progress, too.  

Can I roll over a standard 401(k) into a solo 401(k)?

Most retirement plans can be rolled over into a solo 401(k). For example, an individual who meets their 401(k)’s rollover requirements can typically move assets from one traditional 401(k) into another account—like a solo 401(k). But keep in mind that a Roth individual retirement account (IRA) must be rolled over to another Roth retirement account. 

Self-employed workers are responsible for finding a retirement savings plan that fits their needs. Thankfully, there are many options to choose from. If you work for yourself, you may want to consider some of these self-employed retirement accounts:

Traditional IRA or Roth IRA

These self-employed retirement options are available to business owners with or without employees. There are two types of IRAs to choose from:

• Traditional IRAs: Contributions are made with pre-tax dollars, which could offset taxable income. When withdrawals are made during retirement, they are taxed as regular income. 
• Roth IRAs: This account is funded with after-tax dollars and account holders can make tax-free withdrawals after age 59½. 

SIMPLE IRA

A Savings Incentive Match Plan for Employees (SIMPLE) IRA allows a business to contribute to their employees’ retirement savings. They can also use this type of account to contribute to their own retirement. However, there are some restrictions. 

For example, SIMPLE IRAs are only available for businesses with up to 100 employees. And the business can’t offer another retirement plan. 

In 2023, SIMPLE IRAs have an annual contribution limit of $15,500. Those over 50 can make an additional catch-up contribution of $3,000.

SEP IRA

A simplified employee pension (SEP) IRA can help freelancers, small business owners and self-employed workers save for retirement. Contributions are made by the employer, so business owners can contribute to their own SEP IRA and also to their employees’ accounts. 

SEP IRA participants may contribute up to 25% of their annual compensation, but no more than $61,000. This retirement account doesn't have a Roth option, so all contributions will be made with pre-tax dollars. 

Working for yourself doesn’t mean you have to miss out on saving for the future. There are many retirement plans available for those who are self-employed, including solo 401(k) accounts. 

Qualified individuals can enroll in either a traditional solo 401(k) or a Roth 401(k). In addition to these accounts, you may want to explore other options—like a SIMPLE IRA or an SEP IRA. 

Keep in mind that each of these plans comes with its own contribution limits, tax advantages and eligibility requirements. You could consult a tax adviser to see which self-employed retirement plans are right for you. 

Looking for more ways to save for retirement? Learn how creating a budget could help you reach your financial goals.