A self-employed 401(k)—sometimes called a solo-401(k) or an individual 401(k)—is a type of savings option for small-business owners who don't have any employees (apart from a spouse). That makes these accounts a good fit for sole proprietors, independent consultants, partnerships, and owner-only corporations looking for a retirement plan similar to one they might get from working at a larger company.
In many ways, the self-employed 401(k) works the same way as a standard 401(k). You as the employer, make contributions on your behalf as the employee from your pre-tax earnings, and you can also make contribution as the employer. Those contributions can be combined to invest in a range of vehicles to grow tax-deferred until withdrawn in retirement.
Self-employed 401(k) contribution limits
The highlight of the self-employed 401 (k) is the ability to contribute to the plan in two ways. According to 2023 IRS 401(k) and Profit-Sharing Plan Contribution Limits, as an employee, you can make salary deferral contributions equal to the lesser of $22,500, or 100% of your compensation. If you're at least 50 years old or will turn 50 years old in 2023, your savings options are even higher because you can add an extra $7,500 in catch-up contributions each year. Then, as the employer, you can make a contribution of up to 25% of your compensation each year.
Total contributions to a participant’s account, including catch-up contributions for those age 50 and over, cannot exceed $73,500 for 2023. For those under 50, total contributions cannot exceed $66,000.
Together, those contributions can add up to significant annual savings. For example, if you're an independent consultant under 50 (with no employees) with 2023 compensation of $100,000, you could elect to defer up to $22,500. Then, as the employer, you could contribute $25,000 more based on your compensation minus business expenses and self-employment taxes. In total, you could set aside $47,500 in one year to help build your retirement nest egg.
Self-employed 401(k) contributions may also make you eligible for added tax breaks. If your business is not incorporated, you can generally deduct contributions for yourself from your personal income. If your business is incorporated, you can count the contributions as a business expense.
Setting up your self-employed 401(k) plan
If you decide that a self-employed 401(k) is a good match for your situation, you can set one up through a financial institution that administers 401(k) plans. Because these plans typically involve only 1 or 2 people, they're simpler to administer than a standard 401(k). Accordingly, fees also can be relatively low, with some institutions not charging any setup or maintenance fees for a self-employed 401(k).
When reviewing potential 401(k) plans, make sure you're aware of all applicable fees before signing up. You may also want to look for a plan that offers a wide range of investment options, including mutual funds, stocks, bonds, ETFs, and CDs. Some institutions also offer online tools or telephone assistance to help you pick the right mix of investments for your plan.
Once your plan is up and running, and you've established contribution levels and choosing investments for those funds, be sure to keep detailed records. There is no annual minimum contribution requirement, so you can increase contributions in good years and save less during times when you need more cash for your business.
If your account’s year-end balance is more than $250,000, you terminate the plan, or you find you have an employee that has become eligible, you might be required to file one of the forms in the IRS 5500 series for tax reporting. Learn more about these forms.
Withdrawing funds from a self-employed 401(k)
As with standard 401(k) plans, the self-employed or solo 401(k) is intended to help you save money for retirement, and there are regulations in place to encourage you to do so. For example:
- Distributions may be allowed due to a "triggering event," typically death, disability, plan termination or achieving the age of 59 1/2 or older, but they may be subject to a 10% early withdrawal penalty, along with any applicable income taxes1
- You must take required minimum distributions from self-employed 401(k)s beginning at age 732
- Plans can be structured to allow loans or hardship distributions3
- Plans can be structured to accept rollovers from other retirement accounts, including SEP IRAs and traditional 401(k)s, into your self-employed 401(k)
- In the event of a triggering event, you can roll your self-employed 401(k) assets into another 401(k) (assuming the employer's plan allows rollovers) or an IRA
Because of its high contribution levels, flexible investment options, and relatively easy administration, the self-employed or solo 401(k) is an attractive option for self-employed or small business owners who want to be able to save aggressively for the future.
If there is the potential that your business might add employees at a later date, however, know that you will either have to convert your self-employed 401(k) plan to a standard 401(k), or else terminate it. But if you're confident that you will remain a one-person operation, and you want the high savings options that these plans offer, this type of account may be a good fit.