Boost Retirement Savings with a Solo 401(k)

The solo 401(k) is a valuable retirement savings tool that is underused by many who are eligible for it.

The solo 401(k) is available to the self-employed. Those looking to reduce current income taxes while increasing retirement savings can use a traditional solo 401(k). Those who aren’t too worried about current taxes and want to set up a tax-free retirement account can use a Roth solo 401(k).

A solo 401(k) is available to a self-employed individual who has no employers other than his or her spouse. It can be used before retirement, or it can be used by a retiree who has a profitable part-time retirement business.

Though it can seem confusing, the self-employed worker can make two types of contributions to the solo 401(k), both an employer contribution and an employee contribution.

The employer contribution can be up to 20% of the net income from self-employment. The employer contribution is always made to a traditional 401(k) pretax account. The contribution is deductible and reduces the net self-employment income for the year.

The employer contribution can substantially reduce taxes for the year because it can reduce both income taxes and the self-employment tax.

The limit for the employee contribution is the lesser of the maximum annual 401(k) salary deferral for all 401(k)s and 100% of self-employment income. The maximum annual 401(k) salary deferral in 2024 is $23,000 with an additional $7,500 allowed for workers ages 50 and over.

The employee elects to have that contribution made to either a traditional 401(k) account or a Roth 401(k) account. It also can be divided between the two types of accounts.

The amount contributed to a Rothtype account is included in gross income for the year and taxed, but future distributions from the account are tax free. The amount contributed to a traditional account is excluded from gross income.

The employer contribution is optional. You can make only the employee contribution, which you might want to do if that maximizes the amount you want to save for the year or you don’t need the tax savings from the employer contribution.

The combined employee and employer contributions are subject to the same maximum limit as other 401(k) plans, which is $69,000 in 2024, plus an additional $7,500 for those ages 50 and over.

The limits on contributions can be complicated, especially if the individual also works for or owns other companies that have retirement plans.

It is important that you have an operating business with positive net income and that the business has no employees other than you and your spouse. The business can be operated in any form: sole proprietorship, corporation, S corporation, LLC, or partnership.

You need a written plan and a trust to have a valid solo 401(k).

Most financial services companies now offer no-cost or low-cost solo 401(k) plans for which they serve as plan administrators and custodians. The financial services company has a master plan document with a few optional features. You complete the form, sign it, and have a solo 401(k) plan after the financial services company accepts it.

But many financial firms don’t offer a Roth-type account as part of their solo 401(k)s. If having the Roth option is important to you, be sure to check details before deciding which company to use.