When I close my eyes and imagine my own retirement, I picture a lot of good books, long walks, and mornings spent leisurely sipping coffee on my patio.
But getting there? I know that’s going to take some advanced planning and preparation, particularly when it comes to saving the money I’ll need. The more I save now, the more I can relax when it’s finally time to be done working.
I know why I need to save for retirement, but the how seems way more confusing. IRAs, 401(k)s, Roth, traditional…it’s a whole different world, which makes it all the more challenging to figure out where to turn.
We’ll keep this simple: Whether you're a side hustler or are self-employed full-time, a Solo 401(k) is well worth your consideration. You can skip the frantic Googling—we have your guide to Solo 401(k)s right here.
What is a Solo 401(k)?
“A solo 401(k) is a retirement plan for self-employed individuals with no employees, allowing them to contribute as both employer and employee,” explains William Bevins, CFP CTFA. “This significantly boosts their retirement savings potential.”
...when you’re a side hustler or a business owner, you are both the employer and the employee. And with a Solo 401(k), you can contribute as both, meaning higher contribution limits and, in some cases, a tax deduction.
If you’ve had a 401(k) through a traditional employer before, your company might have kicked in some money (the most common matching formula is for employers to contribute 50 cents for every dollar you put in).
But when you’re a side hustler or a business owner, you are both the employer and the employee. And with a Solo 401(k), you can contribute as both, meaning higher contribution limits and, in some cases, a tax deduction.
That’s the gist. But, within the Solo 401(k) bucket, there are two different options, with the main difference hinging on taxes.
1. Traditional Solo 401(k)
When you opt for a traditional 401(k), you get a break on your current-year taxes because the amount you contribute as the employer is tax deductible. “The tax savings will be based on whatever tax bracket you are in for federal and state,” explains Jon Brunette CPA, Co-owner of Brunette Tax and Accounting LLC.
However, while you get a tax break now, the money will be taxed when you take it out in retirement (you might hear this called “tax deferred”).
“Once you reach a certain age (currently it’s 73), the IRS does require you to start taking out some of these funds and paying tax on that money,” Jon says, noting you need to start doing that whether you need the money at that time or not.
2. Roth Solo 401(k)
With this option, you don’t get a tax deduction for contributing money. “The benefit from this plan is that this money is not taxed when you take it out in retirement, no matter how much it grows,” Jon explains.
Additionally, unlike the traditional 401(k), you don’t have to take money out when you reach a certain age. You’re in control of when you want to start drawing on your savings.
Erin Greenawald
Who is eligible to set up a Solo 401(k)?
As the name implies, the Solo 401(k) exists for side hustlers and solopreneurs. However, there are a few other eligibility criteria to note. You can set up a Solo 401(k) if:
- You are self-employed (it’s fine if you also have a traditional or full-time job—you just need to have some self-employed income coming in)
- You don’t have full-time employees
- You have an employer identification number (EIN)
If you don’t already have an EIN, it’s easy to apply for one through the IRS. And, while having employees will disqualify you from setting up a Solo 401(k), there is one exception: your spouse. If your spouse earns income from your business, that doesn’t rule you out.
What are the benefits of a Solo 401(k)?
For someone with as limited financial knowledge as me, all retirement plans seem like the same thing with different (and confusing) names. However, there are some distinct differences and benefits of a Solo 401(k). Here are the big ones:
More flexibility
You have your choice between a traditional or Roth Solo 401(k). But this plan also gives you the option to choose what you invest your money in, such as stocks, bonds, real estate, crypto, foreign currencies, mutual funds, and more.
“That flexibility caters to erratic income streams common to self-employment,” William says.
Higher contribution limits
Stick with me as we work through some math. If you look strictly at the dollar amount, a Solo 401(k) has the same contribution limit as its other popular alternative: a SEP IRA. That stands for Simplified Employee Pension and it’s another plan specifically made for business owners. Here’s a look at the contribution limits for each:
- Solo 401(k) contribution limit: $66,000 total, broken down into employee and employer contributions. You can contribute $22,500 or 100% of your compensation as the employee (whichever is less), as well as another 25% as the employer.
- SEP IRA contribution limit: $66,000 or 25% of your compensation, whichever is less.
For the sake of simplicity, imagine that your compensation was $100,000 for 2023. With the SEP IRA, you’re limited to putting $25,000 in a SEP IRA (that’s 25% of your compensation).
However, with a Solo 401(k), you can contribute $22,500 as an employee and then another $25,000 as the employer (maxing out the 25% employer match option), bringing your total retirement savings for the year to $47,500—much higher than the $25,000 you could put in a SEP.
If you’re trying to save super aggressively for retirement, a Solo 401(k) gives you more wiggle room to do so.
Whew, okay. That was a lot of numbers. But here are a few more important reminders about contribution limits:
- Solo 401(k)s allow for something called catch-up contributions for people who are age 50 or older. That increases the contribution limit for a Solo 401(k) to $73,500 for 2023 if you’re over 50. Catch-up contributions are not permitted with SEP plans.
- Contribution limits apply across all of your retirement savings plans. So, if you’re side hustling and also stashing away money in an employer-sponsored retirement plan, that counts toward your contribution total. You can’t max out numerous different accounts.
- Contribution limits change every year. In 2024, the SEP IRA and Solo 401(k) contribution limit will increase to $69,000. Make sure to check the limits for the current year so you’re making decisions with updated information.
Which retirement plan is right for you?
Is your head spinning a little? I don’t blame you—there are a lot of numbers and plenty of jargon.
If you’re trying to figure out which retirement route is right for you, here’s a helpful chart breaking down the major differences between the three retirement options we’ve discussed: a traditional Solo 401(k), a Roth Solo 401(k), and a SEP IRA.
As you figure out your options, one of the biggest things to consider is whether or not you have employees or plan to in the near future. If so, a SEP IRA is likely your best option. If not, a Solo 401(K) is an effective way to maximize your retirement contributions.
How to set up your own Solo 401(k)
When you decide you’re ready to actually set up your Solo 401(k) and start stashing away some money for your own dreamy retirement, the best thing you can do is find a Certified Financial Planner (CFP) or broker who can walk you through the process.
It’ll save you a whole lot of glazed eyeballs while trying to figure out the paperwork and your different options.
If you want to go the DIY route, you can set up your Solo 401(k) through a variety of online brokers or use a service built specifically for solopreneurs (just remember, you’ll need an EIN first). Here are a few resources to help:
Save for the retirement you deserve
My own dream retirement might look different from yours. Similarly, the ways we save for those next chapters will probably differ too.
“Individual financial circumstances should guide the final decision,” William says. “Many different retirement plans are available to help individuals meet their retirement needs."
As you explore your options, chat with a financial planner or other trusted expert about a Solo 401(k). If you don’t currently have or plan to have employees and want the flexibility to save aggressively, it could be the best choice to prepare for a retirement that’s every bit as relaxing as you deserve.
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