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Small business owners or self-employed people need to plan for their retirement too, not just W-2 employees. Chances are if you’re one of these, you’ve heard of a Solo 401k or have dabbled in other similar options to set yourself up for a healthy retirement.
Let’s dive into what a Solo 401k is, who exactly it’s for and how it can benefit them, my personal setup, and how it works to set aside tens of thousands of dollars per year for your retirement.
What Is A Solo 401k?
Keep in mind, I’m just a dude with a finance degree, not a licensed professional, and shouldn’t be taken as financial advice. In its most basic form, a Solo 401k is a 401k designed for a business owner with no employees. IRS rules actually prohibit you from having a Solo 401k if you have any W-2 employees on your payroll besides yourself or your spouse.
If you find yourself eligible for this type of account, the 2023 limit is up to $66,000 in the total year. There is also an additional $7,500 ‘catch up’ if you’re over the age of 50, so keep that in mind as well. Sounds like a pretty substantial retirement vehicle, right?
Similarly, the other retirement account small business owners or self-employed people might look at is the SEP IRA. Basically, it will be a much simpler account, free to set up, and may favor those who might not be making as much money: say less than $20,000 being contributed to the account per year.
Who Is A Solo 401k For?
The good news is, there are no age or income restrictions. All that’s required is that you must be a business owner with an EIN (employer identification number) with no W-2 employees. If you check off those boxes, you’re all set and clear to set one up and start contributing!
Keep in mind, this is meant to be a retirement account, so there are restrictions on the funds that you do in fact contribute. Withdrawals before the age of 59.5 will result in a 10% penalty. Additionally, you are required to take minimum withdrawals from your Solo 401k starting at the age of 72.
How Does A Solo 401k Work?
The process for setting up a Solo 401k can actually be fairly cumbersome. There is a spectrum of platforms to set up your ‘account’ (it’s actually more of a document): from free services to more customized plans that individual consultants advise you on. In the middle of that spectrum, you’ll have your companies and services that will most likely be better than the free ones and not as in-depth or pricey as the consultations.
This median is where I found the sweet spot after dozens and dozens of hours of research. More specifically, I landed on Solo401k.com as it appeared to be the cheapest option with all the features I needed. Once that solo 401k is set up, you basically have 3 buckets you can contribute to:
- Pre-tax: Tax deduction today, pay taxes later
- Roth: pay taxes today, but no taxes later
- After-tax: pay taxes today, pay taxes later (this is how you get up to that $61k threshold)
In essence, you get to choose how your funds are treated tax-wise in your solo 401k. With it, you get to act like the employee and the employer and with that you get to defer some of your salary into that solo 401k plan.
- As an “employee,” you can defer up to $20,500 into one of the buckets
- As an “employer,” you can offer yourself a ‘match’ or contribute on a profit-sharing level
For a further in-depth analysis, check out my video here!
My Personal Setup
As an employee, I can contribute up to $22,500 in pre-tax contributions and $43,500 in after-tax, thus hitting that $66,000 benchmark. If you’re curious how I utilize my own solo 401k, I personally use a Mega Backdoor Roth.
The kicker is I can put that whole $66,000 limit into a Roth IRA, which makes it a very compelling case to set up a solo 401k for business owners and self-employed people. Even more so, if you’re younger like me and have the decades to let compound interest take its course, that’s a good chunk of tax-free retirement money!
Important to note once more, I’m just a guy with a degree and a platform. PLEASE talk to a licensed professional to understand the tax strategies and limits further with a solo 401k and the buckets.
Solo 401k Final Explanation
Setting up a solo 401k can be a very confusing process: whether it’s going through a consultation, using a free platform, or using a subscription-based service, the setup can be daunting. Furthermore, tax prepping and utilizing your plan to its most efficient standard is a whole other beast!
Dozens and dozens of hours have led me to a favoring the middle option of a feature-based service that has a big leg up on the free options but is not as pressing as a 1v1 service. Even pairing it with a payroll provider like Gusto that handles the tax side and income side is a hack in itself.
With all of that being said, if you’re ready to get into the realm of setting up your solo 401k, go right here! And if you even want to pair it with a payroll provider, try my very own with Gusto.
