Self-employed individuals have multiple options to save for retirement and invest in a tax-efficient manner. One of those options, the Solo 401(k), can be particularly attractive to entrepreneurs running their own business, including those with both a 9-to-5 corporate employer and a “side-hustle” that earns them additional income.
What is a Solo 401(k)?
A Solo 401(k) plan, also commonly referred to as a solo-k or uni-k, is just like any other 401(k) plan, but is designed to cover a self-employed person with no employees other than his or her spouse. Because it covers only one employee, there is no burdensome nondiscrimination testing every year, which larger employer retirement plans must undergo. A Solo 401(k) also allows for contributions that are flexible in timing and amount, and the ability to make a larger total contribution with the same amount of self-employment income, compared to other options. This is because the plan participant can “wear two hats” and contribute as both the employee and employer. This makes for a powerful savings combination.
Who does a Solo 401(k) make sense for?
A Solo 401(k) is well suited for those with self-employment income, stable cash flow, no employees (other than a spouse), and no plans to hire any in the foreseeable future. While having self-employment income and no employees are requirements, ensuring that there is sufficient cash flow to make contributions is also important.
The plan can also be a fit for those who are self-employed, but only on a part-time basis, and still earn W-2 income from a corporate employer. As a result, contributions can be made to both a Solo 401(k) and company 401(k) plan – as long as each employer is substantially unrelated. There are also contribution limits that apply.
How much can I contribute to a Solo 401(k)?
There are three types of contributions that can be made:
- Employee salary deferrals: The limit is $20,500 and $22,500 in 2022 and 2023, as well as catch-up contributions (if over age 50) of $6,500 for 2022 and $7,500 for 2023, respectively. Salary deferrals can be made on either a pre-tax or Roth (after-tax) basis, depending on the plan custodian.
However, due to changes from Secure Act 2.0, starting in 2026, catch-up contributions must be Roth if compensation exceeds $145,000, indexed for inflation. There are also increased catch-up contributions allowed between ages 60-63, starting in 2025. The salary deferral limit is per person and combined across all 401(k) plans an individual participates in.
- Employer “profit-sharing” contributions: The limit is 25% of self-employed earnings (S-Corp or C-Corp) or 20% of net adjusted self-employed earnings (LLC, partnership, or sole proprietorship). Profit-sharing contributions are always made on a pre-tax basis.
The total contribution limit – combination of salary deferrals and employer contributions – is $61,000/$66,000 for 2022 and 2023, respectively, or $67,500/$73,500 if over age 50. It is important to consult your accountant to calculate the profit-sharing contribution accurately. The profit-sharing limit is determined per planand is not combined between 401(k) plans.
- After-tax (non-Roth) contributions: These can also be made and are subject to the same total contribution limits noted above. However, after-tax contributions are typically undesirable on their own, as they are not tax deductible and future earnings are taxed when withdrawn.
However, after-tax contributions can make sense if the goal is to use the Mega Backdoor Roth strategy, allowing the entire amount contributed to a Solo 401(k) to be Roth. The details are beyond the scope of this article but worth consideration.
What are the deadlines for opening and making contributions to a Solo 401(k)?
Due to the SECURE Act passed in late 2019, the deadline to open a Solo 401(k) is the tax-filing deadline of the taxpayer/entity, including extensions. This means that, depending on the business entity, a Solo 401(k) can be opened as late as September or October of the following year and still allow for prior year contributions, as is the case for SEP IRAs.
If you open a Solo 401(k) but plan to make prior year contributions, please consult a tax professional. While the SECURE Act extended the establishment deadline to open a Solo 401(k), the IRS has not changed its guidance that the plan participant must generally make a salary deferral election by the last day of the calendar year. In other words, to make employee salary deferrals for the first plan year, the plan needs to actually be in existence by December 31!
The deadline for contributions depends on the contribution type, with employer profit-sharing contributions having more flexibility.
Employee salary deferrals – An election must be filed by the end of the year if you do not have a Solo 401(k) open already. The actual dollars must be contributed by the individual tax filing deadline of the following year, including extensions. The contribution deadline to make 2022 employee salary deferrals is April 18, 2023 or October 16, 2023 with a properly filed extension. Starting in 2024, Secure Act 2.0 will allow retroactive salary deferrals for new solo 401(k) plans opened after December 31st of the prior year. Currently, this is not possible.
Employer profit-sharing contributions – These can be made through the employer tax-filing deadline of the following calendar year with extensions, if filed. Sole proprietorships and C-Corps have a contribution deadline of October 16, 2023 (if an extension is filed) while Partnerships and S-Corps have a contribution deadline of September 15, 2023 (if an extension is filed).
Solo 401(k) vs. SEP IRA Contribution Example
Consider John Smith who, in addition to his regular corporate salary, earns $150,000 of consulting income. The consulting income is earned and paid to his business, John Smith LLC, which files as a sole proprietorship. John wants to save more dollars from this consulting income in a tax-advantaged way. The below compares the total contribution(s) possible with an SEP IRA vs. a Solo 401(k) plan:
| SEP IRA | |
| Compensation | $150,000 |
| Allowable % of Compensation | 20% |
| Maximum Profit-Sharing Contribution | $30,000 |
| Solo 401(k) | |
| Compensation | $150,000 |
| Allowable % of Compensation | 20% |
| Maximum Profit-Sharing Contribution | $30,000 |
| 2023 Salary Deferral Limit | $22,500 |
| Total Contribution | $52,500 |
What if I hire employees in the future?
While a Solo 401(k) is best suited for employers who do not plan to hire employees, circumstances can change. Needing to hire employees, after all, is likely a good sign for a business! Several options exist, depending on the circumstances and needs of the business owner:
- The Solo 401(k) could be dissolved and “rolled over” into a Traditional or Roth IRA maintained by the business owner.
- It could be maintained and turned into a safe harbor 401(k) plan, which does require a minimum contribution amount to all employees but, in return, is exempt from annual nondiscrimination testing.
- If there is a significant age gap between the owner and employee(s) or if the owner wishes to set aside significantly more dollars for his/her retirement, options like “New Comparability” Profit-Sharing plans and/or “Defined Benefit” Pension plans exist also.
Can I still make ‘backdoor Roth IRA’ contributions?
Yes, a Solo 401(k) does not affect the ability to make backdoor Roth contributions. Employer sponsored retirement accounts, including a Solo 401(k), are not subject to aggregations in the eyes of the IRS for the purposes of the pro-rata rule. This is another advantage the plan has over an SEP IRA, which would be aggregated with other IRA accounts.
Are there any other considerations or administration requirements?
Yes, once the Solo 401(k) balance exceeds $250,000 at the end of the year, the IRS does require a Form 5500-EZto be filed, similar to other 401(k) plans. Plans with balances below this amount are exempt.
