Solo 401k Basics for Self-Employment Income
This is the second of a multi-part series on retirement accounts for self-employment income.
Those who have or plan to have self-employment income should find this relevant. If you don’t fall in to those categories, you can let curiosity be your guide.
What is a Solo 401k?
The Solo 401k has a ridiculous amount of alternative names. It is also commonly referred to as an Individual 401k, Solo-k, Self-Employed 401k, Uni-k, and the One-Participant 401k, among others. The IRS officially refers to Solo 401k’s as “One-Participant 401k’s“, but I haven’t heard anyone use that terminology, so we’ll stick to Solo 401k’s here.
Despite the confusing number of nicknames, they all refer to the same thing: a 401k plan covering a self-employed individual (an income generating business owner with no employees), or that person and his or her spouse.
There are a few key differences between the employer 401k’s most of us are used to and Solo 401k’s, which we’ll cover in a bit. Outside of those differences, Solo 401k’s very closely resemble Traditional 401k’s and Roth 401k’s we are already familiar with.
What are the Qualifications to Create & Contribute to a Solo 401k?
Unlike the SEP IRA, the Solo 401k has no age or income restrictions. In order to be able to contribute to one, your contributions must come from self-employment income in that year.
As with the SEP IRA, you do not need to be full-time self-employed in order to be eligible. You could be part-time self-employed or earn a side income from a secondary job. Having a Traditional 401k through another employer does not exclude you from being able to start and maintain a separate Solo 401k.
You also do not need to have a registered corporation (LLC, S-Corp, etc.) in order to be eligible.
The other qualifier is that you cannot employ any full-time employees, outside of the exception of a spouse. Full-time employees are considered to be those that work an average of at least 30 hours per week for his/her employer.
Solo 401k Contributions
The defining difference between standard employer 401k plans and Solo 401k’s is that you can make contributions as an employee (similar to standard 401k’s) and as an employer (similar to SEP IRA’s).
As a result, you can contribute much more of your self-employment income to a Solo 401k than you can to a SEP IRA or SIMPLE IRA.
Solo 401k Contribution Limits
The great thing about Solo 401k’s is the ability to contribute as both an employer and an employee and how it can potentially boost your retirement savings to another level.
To recap, the maximum 401k contribution for employees is $18,000 in 2015 and 2016. Individuals age 50 or older can make an additional $6,000 for 2015 and 2016. Contributions can’t exceed 100% of compensation. This maximum is a combined maximum between any other employer 401k and your Solo 401k. For example, if you are under age 50 and have contributed $10,000 to your day job employer sponsored 401k, you can then only contribute $8,000 ($18,000 – $10,000) to your Solo 401k as an employee.
Maximum employer + employee contributions (per eligible employee) are $53,000/$59,000 (catch-up) for 2015 and 2016, or 100% of compensation, whichever is less.
The maximum tax deductible contribution as an employer is 25% of post-contribution net earnings (same as the SEP IRA). For more on this, check out the IRS rate table for self-employed contributions and my previous post on SEP IRA’s.
Solo 401k Contribution Deadlines
There are essentially two different deadlines for Solo 401k contributions.
The first applies to employee contributions. These have the same end of calendar year deadline as other 401k’s.
Non-corporation employer contributions are generally due by the tax deadline for the previous calendar year (typically April 15). Extensions are possible.
If a contribution comes between January 1st and the tax deadline, you can characterize it for the previous or the present calendar year. Contributions for a calendar year must be made prior to filing your taxes for that year.
Solo 401k Contribution Calculators
If you want to double-check your math on how much you can contribute to Solo 401k’s and compare to other retirement accounts, here are a few Solo 401K contribution calculators to play with:
- Vanguard’s retirement plan contribution calculator
- Bankrate’s self-employment plan calculator
- CalcXML retirement plan calculator
Can you Contribute to Both an Employer 401k and a Solo 401k?
If you have employers, outside of yourself, you can contribute to both your employer’s 401k and make contributions to your own Solo 401k as an employer and an employee.
Are there Roth Solo 401k’s?
Yes. Contributions to Solo 401k’s can be pre (Traditional) or post (Roth) tax, unlike SEP IRA’s, which are pre-tax only.
Note that as with employer Roth 401k’s, only employee contributions can be after-tax Roth contributions. All employer contributions are pre-tax.
Can you Roll a Solo 401k Into an IRA?
You can even roll a Traditional or Roth 401k in to a Solo 401k or Roth Solo 401k.
As with all traditional-to-Roth retirement plan rollovers, any amount you roll over is considered taxable income in the year that you roll it over.
Where Can you Open a Solo 401k?
Some of the discount brokers highlighted in my “how to start an online broker account” article have an Solo 401k option, but they are rare. Vanguard, Schwab, and Fidelity offer them. Always be sure to research minimum balance requirements and any associated fees, including account maintenance or inactivity fees before creating your account.
Investment offerings available for Solo 401k’s can vary as well, per broker. And some may not offer a Roth option. So do your homework.
Any Other Considerations to be Aware of?
One notable downside to Solo 401k’s is that they can require more paperwork and administrative responsibilities than IRA’s. You are generally required to file an annual report on IRS Form 5500-SF if your Solo 401k has $250,000 or more in assets at the end of the year.
Other Solo 401k Resources:
If you have any questions, definitely consult with a tax professional and/or a brokerage firm.
Outside of the Solo 401k resources highlighted earlier, you should also check out the following articles:
- IRS Publication 560, Retirement Plans for Small Business, under “Qualified Plans”
- IRS Publication 4222, 401k Plans for Small Businesses
Solo 401k Discussion:
- Have you opened a Solo 401k? If so, why?
- Who is your broker?
- What Solo 401k tips do you have?