Solo 401(k): Contribution limits, eligibility, pros and cons (2024)

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• A solo 401(k) is a retirement plan for business owners with no employees.
• The plan comes with much higher contribution limits than an employer-sponsored 401(k).
• You're still eligible to open a solo 401(k) even if you have income from other jobs.

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What is a solo 401(k)?

A solo 401(k) — or one-participant 401(k) — is a retirement plan for a business owner with no employees. But these plans can cover both you and your spouse.

Solo 401(k) eligibility requirements

To qualify for a solo 401(k), you must be a business owner with no employees. If you have employees, you'll have to consider alternatives like a SEP IRA or SIMPLE IRA.

However, you can use the plan for yourself and your spouse. There are no age or income restrictions, and the money you earn from self-employment doesn't have to be your only source of income. You can still open a solo 401(k) even if you have a full-time job or side gig.

Solo 401(k) contribution limits

As with a 401(k), both the employer and the employee can contribute to the plan. But according to deMauriac, the business owner acts as both the employer and the employee, so both sides can make contributions.

"You can make profit-sharing contributions, as well as pre-tax salary contributions as your own employee," deMauriac explains.

In 2024, you can defer $23,000 of your self-employment income as an employee. You can add on a $7,500 catch-up contribution if you're over 50. For a solo 401(k), the total contribution limit is up to $69,000, plus a $7,500 catch-up contribution.

Solo 401(k) tax advantages

All 401(k) plans offer tax advantages. How that works with a solo 401(k) depends on the type you use.

Traditional solo 401(k): One of the advantages of a traditional solo 401(k) is that you can reduce your taxable income. For instance, "if your income is $80,000 and you defer $20,000 into your solo 401(k), you would have an adjusted tax base of $60,000 on your W-2," Lee says.

The money you invest grows tax-deferred until retirement, and you'll pay taxes when you distribute the funds.

Roth solo 401(k): Unlike a regular Roth IRA, there are no income limits with a Roth solo 401(k). And Lee stresses that one of the advantages is that you fund the account with after-tax earnings. "This is a beautiful thing because you will never have to pay tax on the money that grows."

What are the pros and cons of a solo 401(k)?

One of the biggest benefits of opening a solo 401(k) is that it comes with some of the highest contribution limits. Since you can make contributions as an employer and an employee, you can maximize your contributions.

And while you do have to be self-employed to open a Solo 401(k), it doesn't have to be your only source of income. If you have a full-time job and consult on the side, you're eligible to open a solo 401(k).

You can also choose from a much broader range of assets than you can with a traditional employer-sponsored 401(k). For instance, you can invest in index funds, mutual funds, ETFs, stocks, and bonds.

However, there are some downsides you should consider. Like most retirement plans, you'll get hit with taxes and fees if you withdraw the funds before the age of 59½.

"One disadvantage is that you must have a triggering event, usually retirement or ending employment, to take a distribution," says deMauriac.

And you're responsible for managing the plan and handling the paperwork on your own.

How do I open a solo 401(k)?

Opening a solo 401(k) is a pretty simple process, and you can do it with most brokers. You will need an Employer Identification Number (EIN), a plan adoption agreement, and an application to get started. Once approved, you can begin setting up your contributions and choosing your investments.

What alternatives are there to a solo 401(k)?

If you're on the fence about opening a solo 401(k), here are some other options you can consider:

• SEP IRA: A Simplified Employee Pension (SEP) IRA is a good option for anyone self-employed. This plan comes with much higher contribution limits than a traditional IRA.
• Keogh plan: Keogh plans are retirement plans for self-employed individuals and come with high contribution limits. However, there are more administrative tasks than you'll find with other plans.
• Traditional IRA: With a traditional IRA, you can let your money grow on a tax-deferred basis. You won't pay taxes on the savings until you begin withdrawing the funds at retirement.
• Roth IRA: With a Roth IRA, your money will grow tax-free, and you won't have to pay any taxes at retirement. And you'll have the flexibility to use your contributions for certain qualified expenses.

Is a solo 401(k) right for me?

If you bring in any self-employment income, a solo 401(k) could be a good option for you. The plan comes with a broad range of investment options and high contribution limits. And if your spouse is involved, you can maximize your contributions and save money quickly.

According to Lee, a solo 401(k) works well for married couples and small professional services firms. However, she reiterates that it won't work if you have even one employee.