Quick facts and who qualifies for a solo 401(k)
Quick facts and who qualifies for a solo 401(k)
A solo 401(k) is an individual 401(k) designed for a business
owner with no employees.
In fact, IRS rules say you can’t contribute to a solo 401(k) if you have full-time employees, though you can use the plan to cover both you and your spouse.
The perks of self-employment are plenty, but there’s at least one significant drawback: the lack of an employer-sponsored retirement plan like a 401(k). Enter the solo 401(k), or what the IRS calls a one-participant 401(k). Designed for self-employed workers, a solo 401(k) mimics many of the features of an employer-sponsored plan, without the drag of working for the man.
Solo 401(k) contribution limits
The total solo 401(k) contribution limit is up to $61,000 in 2022 and $66,000 in 2023. There is a catch-up contribution of an extra $6,500 for those 50 or older in 2022 and $7,500 in 2023.
To understand solo 401(k) contribution rules, you want to think of yourself as two people: an employer (of yourself) and an employee (yes, also of yourself). Within that overall $61,000 contribution limit in 2022 and $66,000 in 2023, your contributions are subject to additional limits in each role:
As the employee, you can contribute up to $20,500 in 2022, $22,500 in 2023, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,500 here in 2022 and $7,500 in 2023.
As the employer, you can make an additional profit-sharing contribution of up to 25% of your compensation or net self-employment income, which is your net profit less half your self-employment tax and the plan contributions you made for yourself. The limit on compensation that can be used to factor your contribution is $305,000 in 2022 and $330,000 in 2023
Keep in mind that if you’re side-gigging, employee 401(k) limits apply by person, rather than by plan. That means if you’re also participating in a 401(k) at your day job, the limit applies to contributions across all plans, not each individual plan.
Is Solo 401(k) tax deductible? Solo 401(k) tax advantages
The nice thing about a solo 401(k) is you get to pick your tax advantage: You can opt for the traditional 401(k), under which contributions reduce your income in the year they are made. In that case, distributions in retirement will be taxed as ordinary income. The alternative is the Roth solo 401(k), which offers no initial tax break but allows you to take distributions in retirement tax-free.
In general, a Roth is a better option if you expect your income to be higher in retirement. If you think your income will go down in retirement, opt for the tax break today with a traditional 401(k).
Because of these tax perks, the IRS has pretty strict rules about when you can tap the money you put into either type of account: With few exceptions, you’ll pay taxes and penalties on any distributions before age 59 ½.
Covering your spouse under your solo 401(k)
The IRS allows one exception to the no-employees rule on the solo 401(k): your spouse, if he or she earns income from your business.
That could effectively double the amount you can contribute as a family, depending on your income. Your spouse would make elective deferrals as your employee, up to the $19,500 employee contribution limit (plus the 50-and-older catch-up provision, if applicable). As the employer, you can then make the plan’s profit-sharing contribution for your spouse, of up to 25% of compensation.
