Benefits of a Solo 401(k) Plan for Self-Employed Individuals

By ShareBuilder 401k

Key Takeaways:

  • High yearly contribution limits for a solo 401(k) up to $66,000 per year vs $6,500 with an IRA can help you save more.
  • Contributing enough to your 401(k) could drop you a tax bracket
  • With a Roth 401(k) option you can contribute on an after tax-basis, which means you can have tax-free distributions when you retire, earnings and all!*
  • You can have penalty and tax-free access to your 401(k) via a loan in case of an emergency.
  • Solo 401(k) plans support any owner-only business and spouses. If you add full-time employees, you will need to convert to an employee-based plan.

Solo 401(k) plans offer self-employed and owner-only businesses high saving limits and tax advantages. Also called Individual 401(k)s, these retirement plans allow you to contribute as both the employer and employee. This provides you the ability to maximize your personal retirement contributions and business tax deductions while lowering your personal taxes too.

Save More with Higher Contribution Limits

Solo 401(k) plan contribution limits can be more than ten times that of a Traditional IRA!

There are some notable differences between IRAs and 401(k)s. The biggest is that they have very different contribution limits. For example, you can only contribute up to $6,500 to an IRA for the 2023 tax year (or $7,500 if you’re over age 50). On the other hand, an employee participating in a 401(k) plan can contribute up to $22,500 this year (or $30,000 if over age 50).

However, that’s not all you can put into a Solo 401(k) plan. You can also make employer contributions. That’s the beauty of the self-employed -- you are both the employee and employer. If you’ve heard of employer contributions such as matching or profit-sharing in a 401(k) plan, well, that’s what the company can provide. As an owner-only business, you can contribute up to $66,000 for the 2023 tax year (or $73,500 if over age 50) assuming you have the earnings to do so (there is a calculation –typically 20%-25% of earnings can be contributed as an employer up to the limit).

Solo 401(k) Contribution Limits vs IRA Contribution Limits
  401(k) IRA
Annual limit per individual $66,000
(employee + employer contributions)
Age 50+ catch-up amount $7,500 $1,000
Penalty-free access, if needed Yes, via loan No

Roth 401(k) Option
The Roth 401(k) is a feature available in a 401(k), and it has much higher contribution limits than a Roth IRA – that can help your retirement savings. You can choose to put some, none or all your contributions after-tax into your Roth 401(k), saving up to $22,500 in 2023, or $30,000 if you are 50 years of age or older. Compare this to the Roth IRA, which only allows a maximum contribution up to $6,500 in 2023 ($7,500 if age 50 or over). In addition, the Roth IRA has income limits that may prevent you from utilizing them, but the Roth 401(k) has no income limit.

Roth 401(k) vs. Roth IRA
Attributes Roth 401(k) Roth IRA
Contribution Limit (2023) $22,500 $6,500
Age 50+ Catch-up Amount (2023) $7,500 $1,000
Roth Income Limit None $138,000*

* In 2023, the contribution amount allowed begins to decrease at $138K for single individuals, hitting $0 at $153K. For those filing jointly, the contribution limit begins to decrease at $218K, hitting $0 at $228K.

Roth tax rules are the exact opposite of how traditional tax-deferred 401(k) contributions work. Your tax-deferred contributions will be taxed when you withdraw the money at retirement; however, you receive no tax deduction on Roth contributions. The benefit is that your Roth withdrawals (including investment gains) can be taken tax-free when you reach retirement age (generally 59 ½ years of age).

Get Emergency Access to Monies
Unlike an IRA, the 401(k) plan can include a loan feature, which gives you more flexibility when you need to take funds out of your retirement plan. If you pull funds out of an IRA before age 59 ½, you’ll typically pay taxes on those funds along with an early withdrawal penalty. However, these penalties can be avoided when taking a loan from a 401(k) plan. The loan feature allows you to request up to half of the assets in your 401(k), not to exceed $50,000, and typically must be repaid within a 5-year period to avoid taxes or penalties. This is typically a pretty automated payback process to your account.

Your Savings Can Add Up with Compounding†

Power of Compounding

Because earnings in a 401(k) plan can compound with market growth, dividends, and/or interest, over time your money can grow in an exciting way. In the hypothetical example shown here, you can see how a one-time contribution of $1,000 could turn into $20,000 over a 40-year career.

†This example compares how a one-time investment of $1,000 can grow over time assuming an 8.0% fixed annual rate of return. Your account may earn more or less. This is a hypothetical example only, and not a guarantee of future returns. Actual experience will vary with portfolio selections and changing market conditions. The total account balance does not take into account federal and state income taxes, which will be due upon withdrawal. Assets withdrawn before 59½ may incur a 10% tax penalty.

You can roll your 401(k) over to another 401(k) if you decide to start another company or convert to an IRA if/when you leave the business or retire.

How Can We Help?
Choosing the right 401(k) plan and understanding the ins and outs can be challenging. Give us a call – we help thousands of small businesses and take the time to learn about your business, so you find the right plan to achieve your tax and retirement saving needs.

For more info and FAQs, you can also visit our Solo 401(k) page. Happy saving!

Meet the Author

Our low-cost 401k plans are easy to setup online and are supported by our 401k advisors and specialists. ShareBuilder 401k serves small business and medium-sized companies, as well as the self-employed. We offer Roth 401k, Safe Harbor 401k, Traditional 401k, and Solo 401k options. Your 401k plan is paired with investment management expertise and employee education to help you save more.