Solo 401(k) plan

This article contains details specific to United States (US) investors. It does not apply to non-US investors.

A Solo 401(k), (also known as a Self Employed 401(k), One-Participant 401(k), or Individual 401(k)), is a 401(k) qualified retirement plan for Americans that was designed specifically for employers with no full-time employees other than the business owner(s) and their spouse(s). You can qualify if your business is organized as a sole proprietorship, a partnership, or a corporation (including both subchapter S and C corporations). The Solo 401(k) plan was enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

As a qualified plan, employee salary deferrals and employer contributions are made with pre-tax earnings, and invested funds are tax-deferred until they are withdrawn. Beginning in 2006, Solo 401(k) plans were permitted to offer designated Roth accounts which could accept designated Roth contributions. Designated Roth contributions are made with after-tax money and withdrawals are generally tax free.

To take a deduction for contributions for a tax year, your plan must be set up (adopted) by the last day of that year (December 31 for calendar-year employers).

As with all qualified plans, withdrawals prior to age 59 1/2 (age 55 if you are terminated) are subject to a 10% penalty tax, and required minimum distributions must begin at age 70 1/2 for retired individuals.

Contribution limits

A Solo 401(k) contribution consists of two standard parts, an employee salary deferral contribution and an employer profit sharing contribution and an optional third part; employee after-tax contributions (currently only available from custom plans). The maximum allowable salary deferral contribution is $23,000 in 2024, $23,500 in 2025 (not to exceed 100% of pay and no more than $345,000 of pay for 2024, $350,000 for 2025 can be taken into account). If one is age 50 or older one can make a maximum $7,500 catch up contribution. Depending on how the business is organized, 25% of employee salary or 20% of business earnings can be used for employer contributions. The combined employee and employer maximum contributions are subject to the lesser of 100% of compensation or $69,000 in 2024 or $70,000 in 2025. The catch-up contributions do not count towards this limit. Both salary deferrals and profit sharing contributions are discretionary, so contribution levels can be adjusted to the fluctuations of business income.

Solo 401(k) Contribution Calculation - for an S or C corporation or an LLC taxed as a corporation

• For W-2 Shareholder-employees: Your compensation is your W-2 box 1 with Box 12 pre-tax contributions added back in.
• Employee Salary Deferral Contribution: 100% of compensation up to the maximum of $23,000 in 2024, $23,500 in 2025 (or $30,500 in 2024, $31,000 in 2024 if age 50 or older) can be contributed to an Individual 401(k).
• Employer Profit Sharing Contribution: A profit sharing contribution up to 25% of compensation can be contributed into an Individual 401(k).
• Employee after-tax Contribution: 100% of compensation. The maximum employee after-tax contribution is the lesser of the two annual addition limits - employee deferrals - employer contributions.

Solo 401(k) Contribution Calculation - for a sole proprietorship, partnership or an LLC taxed as a sole proprietorship

• Employee Salary Deferral Contribution: These business organizations do not provide a W-2 salary to the business owner. The employee salary deferral contribution is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax (this is termed net adjusted business profit). 100% of net adjusted business profits up to the maximum of $23,000 in 2024, $23,5000 in 2025 (or $30,500 in 2024, $31,000 in 2025 if age 50 or older) can be contributed as employee salary deferrals into an Individual 401(k).
• For self-employed individuals, your compensation takes into account both the following items from your business profit:
  • The deduction for the deductible part of your self-employment tax.
  • The deduction for employer contributions on your behalf to the plan.

The calculation of the allowable contribution is figured on worksheets and tables from Publication 560 Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans). See Self-Employed Individuals – Calculating Your Own Retirement-Plan Contribution and Deduction for an illustration. In effect, solving for maximum employee deferral = net adjusted business profit - (employer contributions * 2).

• Employer Profit Sharing Contribution: An employer profit sharing contribution can be made up to 20% of net adjusted businesses profit. Net adjusted business profit is calculated by taking gross self-employment income and then subtracting business expenses and then subtracting 1/2 of the self-employment tax.
• Employee After-tax Contribution: 100% of net adjusted business profits. Your maximum after-tax contributions are limited to the $61K/$66K limit - employee deferrals - employer contributions and are additionally limited to business profit - 1/2 SE tax - employee deferrals - (employer contributions * 2).

Loan provisions

Not all Solo 401(k) plans allow loans.

If the Solo 401(k) plan document has a loan provision you can take a loan from the plan. Loans are limited up to 50% of the total 401(k) value up to a maximum of $50,000. Generally, Solo 401(k) loans have a 5-year maximum repayment term although loans used for the purchase of a primary residence may extend the loan repayment term up to 10-15 years. Loans must be repaid according to the terms of the loan amortization schedule which is provided when a loan is initiated.

Generally, the loan interest rate charged is the Prime Rate or Prime plus 1% or 2%. The interest rate depends on the Solo 401(k) provider. Failure to pay the loan according to the loan terms can trigger taxes and early withdrawal penalties, since the IRS deems the unpaid loan as an early distribution from the retirement account.

Account rollovers

Not all Solo 401(k) plans accept incoming rollovers.

If the Solo 401(k) plan document accepts rollovers, money can be transferred into the Solo 401(k) plan from traditional IRA, SEP, Qualified Plans or Keoghs (profit sharing, money purchase pension, defined benefit), 401(k), 403(b) and governmental 457 plans. SIMPLE IRAs are eligible for rollover after a two year holding period is met. A "traditional" Solo 401(k) plan can be rolled over to another "traditional" 401(k) plan and into traditional IRA and rollover IRAs. Designated Roth accounts in a Solo 401(k) plan can be rolled over to another 401(k) plan with designated Roth accounts or to a Roth IRA.

Designated Roth accounts

Not all plans allow designated Roth accounts. If the plan document allows designated Roth accounts, you can make after-tax contributions to the designated Roth accounts in the Solo 401(k) plan and take tax free distributions of contributions and qualified earnings. Keep in mind the following features of designated Roth accounts in a Solo 401(k) plan:

1. The income limitations for contributing to a Roth IRA do not apply to making designated Roth contributions to a Solo 401(k) plan. The designated Roth accounts in a Solo 401(k) make it possible for high income self-employed individuals to make Roth contributions.
2. The designated Roth account is forbidden from taking employer contributions. The employer contributions must be made to the pre-tax Solo 401(k) account.
3. Ordering rules for Roth IRA distributions do not apply to designated Roth accounts. Any distribution from the account is prorated according to the proportion of account basis and earnings in the account.
4. Withdrawals of earnings from a designated Roth account are subject to a penalty tax if they are taken prior to age 59 1/2 and if the account has not passed a five-year holding period. The five-year holding period does not carry over to a Roth IRA rollover. A rollover to a first time Roth IRA begins the holding period for the rollover. A rollover into an existing Roth IRA will receive the tenure of the existing IRA.

Solo 401(k) advantages

General Features of a Solo 401(k) Plan: Plan Establishment: Business owners with no additional employees other than the spouse of the owner or partnerships whose only employees are self-employed partners and their spouses. Trustee and Plan Administrator: Business owner, spouse or partner or any combination, or any other designated third party. Salary Deferral Contributions: Up to $23,000 in 2024, $23,500 in 2025 (not to exceed 100% of pay and no more than $345,000 in 2024, $350,000 in 2025, of pay can be taken into account). Total salary deferral and employer contributions cannot exceed $69,000 in 2024, $70,000 in 2025. Catch-up Contributions: In 2024 and 2025, individuals age 50 or older may contribute an additional $7,500 in salary deferrals beyond the $23,000 or $23,500 which does not count towards the maximum total contribution limit of $69,000 or $70,000. Employer Contributions: Up to 25% of pay, (20% of net adjusted business profits for self-employed). The maximum combined salary deferral and employer contributions limit is $69,000 in 2024, $70,000 in 2025. Rollovers: A plan may allow rollovers and transfers from traditional IRA, SEP, Qualified Plans or Keoghs (Profit Sharing, Money Purchase Pension, Defined Benefit), 401(k), 403(b) and governmental 457 plans. SIMPLE IRAs are eligible for rollover after two year holding period is met. Loans: A plan may allow loans to all participants, including unincorporated business owners. Government Reporting : IRS 5500-EZ (and Instructions)."
-- 401khelpceneter.com

Individuals who qualify for the Individual 401(k) have the following advantages:

1. The potential to shelter more earnings in the the Solo 401(k) than in a SEP or SIMPLE IRA.
2. The Solo 401(k) can allow for loan provisions.
3. The Solo 401(k) can provide a Designated Roth 401(k) account.

Solo 401(k) caveats

Individuals considering a Solo 401(k) should keep in mind the following:

1. Complexity and Costs: Although a Solo 401(k) plan is much simpler and less expensive than most standard 401(k) plans, costs and administrative burdens are critical factors to consider. The addition of plan options, such as loan provisions and designated Roth options may increase plan costs. Individuals will usually bear the following administrative tasks with the Solo 401(k) plan:
   1. You must maintain accurate records, including beneficiary files for plan participants, and submit all required reports and notices to participants, the IRS (including 5500-EZ reporting), and the Department of Labor.
   2. You must determine when employees are entitled to benefits under the plan.
   3. You must instruct the investment custodian regarding plan contributions and distributions.
2. Potential Solo 401(k) participants come from two basic groups: individual owners of businesses, and business employees who have outside consulting contracts or freelance earnings that are reported on IRS schedule C returns. These individuals may be contributing to their company's 401(k) plan. The annual employee contribution limits apply to all 401(k) plans, so if you are maxing out your employer plan you can only make employer contributions to a Solo 401(k) plan.
3. If your business is likely to expand and require the addition of employees, the Solo 401(k) plan must become a full fledged standard 401(k) plan or be terminated.
4. A solo 401(k) plan may offer less asset protection than a standard 401(k) plan, because solo 401(k) plans are technically not ERISA plans.

You may find this Solo 401k FAQ to be helpful.

Solo 401(k) offerings

Currently a growing number of investment firms are offering Solo 401(k) plans to self-employed individuals.

• E*TRADE
• Fidelity
• Schwab
• T. Rowe Price
• Vanguard

See Where To Open Your Solo 401K | The White Coat Investor and Comparing The Most Popular Solo 401k Options for some details on several plans.

External links

• Bogleheads forum topic: "Solo 401(k) Plan"
• 401khelpcenter.com
• Solo 401k Beacon Capital Management Advisors
• Vanguard Individual 401(k) Plan
• The Single-Participant 401(k) , Juliette Fairley and Peter D. Fleming, Journal of Accountancy, March 2003.
• One-Participant 401(k) Plans, IRS overview of the Solo 401(k) plan.
• IRS Form 5500-EZ Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan, from the IRS
• IRS Instructions for Form 5500-EZ, Annual Return of One-Participant(Owners and Their Spouses) Retirement Plan, from the IRS