Contribution rules, limits, and best practices for a solo 401(k)

Just because you are self-employed does not mean you can’t save for retirement and build your wealth. In fact, there are a few major advantages for you to reap.

A solo 401(k) plan is one of many retirement and savings plans available to self-employed individuals and other small businesses. No two options are the same though. While a SEP Plan is a popular plan for entrepreneurs, you could be missing out on the advantages (and higher contribution limits) of a solo 401(k).

These limits (and best practices around them) can be a bit fuzzy for some, so in this article, we will break down the contribution limits for a solo 401(k), deadlines for contributions, and best practices for contributing to your plan and saving for the future. 

What is a solo 401(k)?

Like an employer-provided 401(k), a solo 401(k) plan allows you to save for your retirement, invest, and reduce your taxable income. 

A Solo 401(k) is a retirement plan geared specifically toward the unique needs of self-employed individuals and micro-business owners with no employees. One of its most appealing features is that it permits an enrollee to wear two contributor’s hats: one as an employee and another as an employer. 

Under the right circumstances, even the spouse of a participant can contribute to a Solo 401(k) since the spouse of the owner is also considered an owner.  The main thing to keep the plan under its Solok status is the employer should have no employees that are a nonowner. Another term for that is the employer does not have any rank-and-file employees.  

Solo 401(k)s are one of the best options for solopreneurs and self-employed individuals, but there are limits and rules to be aware of. Read on to learn more about the rules and best practices for your solo 401(k).

How solo 401(k) contributions work

If you had a 401(k) plan with a previous employer, you are probably used to contributing regularly to it out of your paycheck while your employer matches up to a certain percentage. 

The benefit of a solo 401(k) plan is that because you are an employer you get to make contributions as the employer as well as an employee. Because of this, you get more flexibility and control over how much you can contribute, and what you can invest in. 

Solo 401(k) contribution limits

As of 2023, 401(k) plans have a contribution limit of 22,500 ($30,000 if you are 50+), while a solo 401(k) plan allows you to contribute up to $66,000 and $73,500 if you're aged 50+. Assuming, of course, your income will support the contribution. 

This limit can be broken down as such:

As an employee of your business:

• You can contribute up to $22,500 ($30,000 if you are 50+ years old)

• Your contributions can be pre-tax, Roth, after-tax, or a mix of all three.

The employee contributions are also called “effective deferral” or “employee deferral”. These function similarly to how you would contribute to a 401(k) plan with your full-time job. 

The limit however is based on all deferrals you make to all plans you participate in combined. 

As an employer (of yourself):

• You can contribute up to 25% of your compensation if your business is incorporated (20% if not)

• These contributions are made on a pre-tax basis. 

The employer contributions are also referred to as “profit sharing” and function similarly to how an employer would contribute to your 401(k) with a matching contribution. That is the beauty of a solo 401(k) - because you contribute to both the employee and employer side, you can contribute more than you would to a 401(k) plan of an employer you work for. 

There is another caveat. Solo 401(k) plans allow for “catch-up” contributions, which are allowed for those over 50 years old. If you are going to be at least 50 years old by December 31st of the year you would like to contribute then, as of 2023, you can make an additional contribution of $7,500. To get a catch-up contribution you must max out the employee contribution limit first.

The IRS has a few stipulations to be aware of:

• Your contribution to your solo 401(k) cannot exceed what you earn. It must be 100% of your net income, up to the $22,500 limit (or $30,000 if you are 50 or older).

• You can only contribute to a solo 401(k) based on your earned self-employment income or W-2 income you pay yourself as an employee under your business.  Unfortunately, you can not make contributions based on the income you receive as an employee of another employer. 

Solo 401(k) contribution examples

This all gets a bit theoretical, so let’s look at a practical (hypothetical) example. 

Let’s suppose that we have an entrepreneur named Andrew. Andrew is 40 years old and self-employed with no employees so he qualifies for a solo 401(k). Andrew’s net self-employment income (after expenses) for the year is $100,000. How much can Andrew contribute?

• As an “employee,” Andrew can contribute 100% of his income up to the limit (which as of 2023 is $22,500)

• As the "employer", Andrew can contribute an additional 25% of his adjusted net self-employment income. In this case, that would be 25% (20% after adjustment) of $100,000, which equals $20,000.  See IRS Publication 560

Andrew’s total contribution is $22,500 + $20,000 which equals $42,500. Not bad!

Now let’s say Andrew’s business grows (and we will still assume the 2023 limits), and he makes $500,000. In this case, he still will max out his “employee” contribution, however, he will be able to increase his “employer” contribution:

• As an “employee,” Andrew can contribute 100% of his income up to the limit (which as of 2023 is $22,500)

• As the "employer", Andrew can contribute an additional 25% of his adjusted net self-employment income. In this case, that would be 25% (20% after adjustment)  of $500,000, which equals $100,000. This goes over the total limit though, so let’s account for that. 

It's important to remember that the overall limit for combined employer and employee contributions to a Solo 401(k) is $66,000 as of 2023 (this does not include the additional $7,500 in catch-up contributions allowed for individuals age 50+). So even though 25% (20% after adjustments) of Andrew's income would be $100,000, the maximum he could contribute as an employer would be $66,000 - $22,500 (employee contribution), which equals $43,500. 

All told Andrew can contribute $66,000 to his solo 401(k).

Solo 401(k) contribution deadlines

To comply with tax regulations, you need to ensure that you are contributing to your solo 401(k) within the deadlines outlined by the IRS. Since you contribute to both the employee side and the employer side, there are two deadlines that you need to be aware of.

1. Employee deferral contributions: For self-employed individuals, they can make their deferrals up until their tax return due date plus extensions. For W-2 paid employers, they must deposit the deferrals within 7 business days. 

2. Employer contributions: These can be made up until the business's tax filing deadline, including extensions. For most self-employed individuals, this would be April 15 of the following year, or October 15 if an extension was filed.

To establish a new Solo 401(k) plan, the plan can be established and funded by the employer’s tax return due date plus extensions.  However, it's best to get started earlier to allow time for the paperwork to be processed.

How do solo 401(k) contribution limits compare to other options?

One of the strengths of a solo 401(k) lies in the fact that you can contribute more to it than other retirement accounts available to entrepreneurs. 

Remember from above, as of 2023 the total maximum contribution you can make is 66,000 (excluding the $7,500 catchup available for those 50 or older). Here’s how a solo 401(k) stacks up against other options:

• SEP IRA (Simplified Employee Pension): SEP IRAs only allow for employer contributions, which can be up to 25% of your net self-employment income, with a limit of $66,000 in 2023. Unlike Solo 401(k) plans, there are no catch-up contributions or Roth options.

• SIMPLE IRA (Savings Incentive Match Plan for Employees): As of 2023, you can make salary deferrals of up to $15,500 ($3,500 as a catch-up contribution if you are 50 or older). As an "employer," you're generally required to make either a matching contribution of up to 3% of your net self-employment income or a 2% fixed contribution for all eligible employees.

• Traditional and Roth IRA: These IRAs have much lower contribution limits. As of 2023, you can contribute up to $6,500 or $7,500 if you are 50 or older.

On paper, the SEP IRA seems identical to a solo 401(k), however, there is one key difference to remember. A SEP IRA allows you to contribute 25% of your self-employment income up to a limit, while a solo 401(k) allows you to contribute your employee contribution up to the maximum limit as well as an employer contribution called a profit-sharing contribution.  Both employer and employee contributions however cannot exceed the $66,000 for 2023. In addition, since the maximum employee contribution is met if you are aged 50 you can make an additional catch-up contribution of $7,500

While the max limits are the same, a solo 401(k) allows you to contribute more quickly, allowing you to set aside more for retirement from the get-go.

Solo 401(k) withdrawal rules

Just as you have rules around withdrawing from a 401(k) plan from your employer, solo 401(k) plans have their own set of rules around withdrawing funds. 

Like other retirement accounts, you have to wait until you are 59 ½ before you can withdraw. Otherwise, you will be hit with a 10% penalty, plus income tax.

Solo 401(k) plans also have required minimum distributions (RMDs), once you hit 73 years old you will have to take out a certain amount annually. There is no strict schedule on how you take out your distributions though. You could set up a regular withdrawal from your Solo 401(k), or you could take one distribution for the year. As long as you receive your full distribution amount for the year, you are all set. This amount is determined based on your balance divided by your life expectancy. Missing a distribution will result in a 25% penalty on the value of the distribution and could be a cause for plan disqualification. 

As with any retirement account, the rules (and tax implications) around withdrawals can get fuzzy for some. We recommend running any questions you have by a tax professional, though the Sepira(k) platform can be of help here in keeping records for your account as well as providing compliance support and necessary forms for tax purposes. 

Solo 401(k) rollover rules

Whether you left a full-time job and have a 401(k) account that needs to be rolled over, or a separate account (such as an IRA), you have plenty of options (and guidelines) around rolling over into a solo 401(k) account.

In fact, you can roll over almost any type of retirement plan into a solo 401(k). This includes:

• Traditional IRA

• An existing 401(k) plan (either an employee-provided 401(k) or a separate solo 401(k))

• 403b (tax-sheltered annuity plan or TSA)

• Pension plan

• TSP (thrift savings plan)

The only retirement plan that cannot be rolled over is a Roth IRA per IRS rules.

Who will help me roll over into a solo 401(k)?

If you want to roll over an existing retirement plan into a solo 401(k), we’re here to help.

The Sepira(k) platform can help you if you are rolling over from a separate solo 401(k) account or creating an account for the first time. Check out our plans to see which is the right fit for you, and create an account to start saving today.  

Solo 401(k) Eligibility rules

There are two requirements to be eligible for a solo 401(k):

• You must be self-employed, or have a small business with partners, either full-time or part-time, and actively earning income

• You cannot have any full-time employees (except a spouse and other partners)

Whether you are a sole proprietor, an LLC, or a corporation if you meet these requirements then you are eligible for a solo 401(k) plan. While these requirements may seem simple on the surface, there is a bit to unpack so check out our guide to the eligibility requirements for opening a solo 401(k).

How to open a solo 401(k)

While a solo 401(k) (like any investment account) can seem complex at first, we hope that this article gives you a firm foundation and understanding of the rules and best practices for managing a solo 401(k). 

If you are self-employed or have a small business 

and meet the eligibility requirements, then a solo 401(k) is a fantastic way to save for retirement, reduce your taxable income, and grow your wealth. The added advantage of a solo 401(k) is that because you act as the employer and employee, you can contribute more to your solo 401(k) than you would be able to in a traditional 401(k) with a full-time job. 

If you are ready to start saving and reap all the advantages of a solo 401(k), then create an account with Sepira(k). Opening a solo 401(k) account on our platform is easy, whether you have an existing solo 401(k) or are opening your very first account, we can help. Browse our plans to see which is the right fit for you, and start saving today.