The Solo 401k provides self-employed individuals with a robust retirement savings vehicle, high contribution limits, and significant tax advantages. It's designed to mimic the benefits of an employer-sponsored 401k without the complexities of managing a larger plan with multiple participants.
Solo 401k Eligibility
- Must be self-employed or a small business owner with no full-time employees other than you and your spouse.
- Freelancers, independent contractors, and sole proprietors are good examples.
- If the business grows and you hire employees, you are no longer eligible to contribute, and new types of retirement accounts will need to be established.
Contribution Limits
One of the primary benefits of any 401k is its high contribution limits, which allow for substantial retirement savings:
- Employee Contributions: Up to $23,000 (for 2024) or $30,500 if you are 50 or older (catch-up contributions).
- Employer Contributions: Up to 25% of employee compensation.
- Total Contributions: Combined employee and employer contributions cannot exceed $69,000 (or $76,500, including catch-up contributions for those over 50).
Tax Advantages of Solo 401ks
- Traditional Solo 401k: Contributions are made with pre-tax dollars, reducing taxable income for the year. Taxes are then paid upon withdrawal.
- Roth Solo 401k: Contributions are made with after-tax dollars. Withdrawals are tax-free in retirement, provided certain conditions are met (like age and length of account ownership).
Flexible Withdrawals
- Typical Withdrawal: Money can be withdrawn when the account holder is at least 59½ years old and has had the account for at least five years. If money is taken early, a 10% penalty plus current income tax must be paid.
- Loans: Account holders can usually borrow money from their Solo 401k plan, up to 50% of the account balance or $50,000, whichever is less. The funds will need to be replaced in 5 years or less. Interest needs to be included in that replacement figure at a similar rate to what it would have been earning in the 401k. If the money is utilized to purchase a home, it does not need to be replaced for up to 30 years.
- Other exceptions to early withdrawal may exist, like medical hardship or disability.
- Required Minimum Distributions (RMDs): Starting around age 70, individuals must take minimum distributions or withdrawals from their 401k accounts. The IRS calculates these RMDs based on life expectancy and the balance in the account, but as a general rule of thumb, in 2024, RMDs are required at:
- 73 if you turn age 72 on or after Jan. 1, 2023
- 72 if you turn 70½ between Jan. 1, 2020, and Dec. 31, 2022
- 70½ if you turned that age on or before Dec. 31, 2019
- If the required amount isn't taken out, a hefty penalty of 50% can be incurred on the amount that should have been withdrawn but wasn't. Account holders can also take more than the RMD, but not less.
Administrative Requirements
While a Solo 401k is simpler than a traditional employer sponsored 401k plan, it still requires some administration:
- Published Plan: A written document must detail the type of 401k plan provided.
- Annual Reporting: Depending on the amount contributed and the business structure, Form 5500 or a version of it will be submitted to the IRS.
- Record-Keeping: Maintain detailed records of contributions, loans, and distributions in the event of an audit.
Benefits of a Solo 401k
- High Contribution Limits: Ability to save more annually compared to other retirement accounts like Individual Retirement Accounts (IRAs).
- Tax Savings: Significant tax deductions through Traditional pre-tax contributions or tax-free withdrawals with Roth contributions.
- Investment Control: A broad range of investment options allows for personalized investment strategies.
- Loan Options: Ability to borrow from the account, providing financial flexibility.
- Independent Retirement Planning: Even self-employed or freelancers can leverage this retirement plan and tax benefits.
