What Is a Solo 401(k)?

There are many benefits of self-employment. But if you're looking to contribute toward your retirement, you might be wondering if you can manage your own 401(k).

Fortunately, setting up a solo 401(k) is an option for many small business owners and self-employed individuals. Learn more about self-managed 401(k) plans and see if one could be right for you.

What Is a Solo 401(k)?

Also known as a self-managed 401(k) or one-participant 401(k), these retirement plans are designed for self-employed individuals with no employees. They have the same rules and general features as any other 401(k) plan. This means that many self-employed workers can enjoy the same retirement benefits that larger businesses offer.

Rules For Self-Managed 401(k)s

Solo 401(k) plan rules are generally the same as other employer-sponsored plans.

Here's a brief summary of the rules:

• Eligibility: You must be a business owner with no full-time employees, with one exception: Spouses on the payroll of the self-employed individual may make contributions. There are no age restrictions or minimum income requirements.
• Contribution limits: $22,500 for 2023, plus the option of a $7,500 "catch-up" contribution for individuals age 50 or over.¹ The self-employed individual can also make contributions as the employer, thereby contributing a higher amount. The total contribution limit is up to $66,000 for 2023, depending on other qualifications.
• Taxes on contributions: Traditional 401(k) contributions are made on a pre-tax basis, reducing taxable income for the tax year. Roth 401(k) contributions are made on an after-tax basis.
• Taxes on withdrawals: Qualified distributions from a traditional 401(k) in retirement are taxed as ordinary income. Qualified distributions from Roth 401(k) money can be withdrawn without incurring tax penalties.

Can I Manage My Own 401(k)?

Setting up a solo 401(k) can be relatively simple. However, a self-managed 401(k) is not exactly a "set-it-and-forget-it" plan.

Some areas where help is often needed include establishing the account, managing investments, and annual reporting.

Here are more details on what kind of management you'll need to do for a solo 401(k):

• Opening the account: You can open a solo 401(k) with most online brokers or some large mutual fund companies. You'll need to complete a plan adoption agreement to set up the 401(k) plan.
• Managing investments: The provider can help you choose the plan investment choices, which are typically mutual funds. As with other investment accounts, it's generally wise to invest in a diverse set of funds, which can help spread risk across multiple investment categories.
• Making contributions: It can be wise to establish periodic contributions, such as monthly, and automate them. This can help to build your retirement savings while you focus on your business.
• Annual reporting: Solo 401(k) plans may require additional paperwork after the initial set up, such as the annual IRS filing of Form 5500.²

Alternatives to a Solo 401(k)

A solo 401(k) can be a good retirement plan for self-employed individuals, but it may not be the best choice for everyone. For example, in some cases, another type of retirement plan may be more suitable. Solo 401(k) alternatives to consider include an individual retirement account (IRA) or a simplified employee pension plan (SEP).

IRAs

An IRA can be a good choice for self-employed individuals who can't afford the maximum 401(k) contribution and whose income doesn't exceed the tax-deductible contribution limit set by the IRS. 

Individuals age 50 and above may make an annual $1,000 "catch-up" contribution.

The income limits for deductible contributions will depend on the type of IRA and filing status. Here are the lower income limits to make a full IRA contribution for 2023:³

• Traditional IRA income limits: $83,000 for single, head of household, or married filing separately; $136,000 for married filing jointly. Above these thresholds, deductible contribution limits begin to phase out.
• Roth IRA income limits: $153,000 for single, head of household, or married filing separately; $228,000 for married filing jointly. Above these thresholds, contribution limits begin to phase out.

You can continue contributing to a traditional IRA if you exceed the income limits, but some of your contributions may not be tax-deductible.

SEP IRA

A SEP IRA is an individual retirement account designed for small business owners. Employers may contribute up to either 25% of each employees' pay or $66,000 per year, whichever is less.⁴ A SEP IRA can be a good alternative to a solo 401(k) because SEPs are generally easier and less costly to set up and manage.

Bottom Line

A solo 401(k) can be a good retirement plan option for self-employed individuals who do not have full-time employees. However, self-managed 401(k) plans may not be the best choice for every self-employed business owner. In some cases, an IRA or a SEP IRA may be more suitable. Ultimately, it's wise to consult the guidance of a financial professional to choose the best retirement plan type for you.

Sources

1. One-participant 401(k) plans. Internal Revenue Service. https://www.irs.gov/retirement-plans/one-participant-401k-plans. Last updated October 27, 2022. Accessed November 28, 2022.
2. Form 5500 corner. Internal Revenue Service. https://www.irs.gov/retirement-plans/form-5500-corner. Last updated July 5, 2022. Accessed August 4, 2022.
3. 401(k) limit increases to $22,500 for 2023, IRA limit rises to $6,500. Internal Revenue Service. https://www.irs.gov/newsroom/401k-limit-increases-to-22500-for-2023-ira-limit-rises-to-6500. Last updated October 24, 2022. Accessed November 28, 2022.
4. SEP Contribution Limits (including grandfathered SARSEPs). Internal Revenue Service. https://www.irs.gov/retirement-plans/plan-participant-employee/sep-contribution-limits-including-grandfathered-sarseps. Last updated October 26, 2022. Accessed November 28, 2022.