Almost everyone dreams about the freedom and self-determination of being self-employed. People want to reap the full financial benefits of their work instead of giving it away as a profit for others. What holds many people back from achieving their dream is the insecurity of not having a retirement fund for their old age. But there is a reliable answer that can make your dream come true. The question that you need to ask is “what is a Solo 401k?” The answer is that it is an employer-sponsored Solo 401k retirement account designed for the self-employed. Typically, it comes with more benefits and fewer restrictions than what major employers offer in a 401k. The Solo 401k makes it all available without the hassles of working for others and giving away the profits earned from your work.
What is a Solo 401k Plan and How Does it Work?
The Solo 401k is the everyday phrase given to the retirement account that the IRS calls a one-participant 401(k) plan. The simplest definition for what is a Solo 401k is a retirement account designed for individual business owners with no employees. Other than the no employee restriction, the Solo 401k has all the same benefits and features as a major employer’s 401k (plus many more). But the Solo 401k is even better because it does not impose the restrictions that major employers impose but the IRS does not require. The most notable restriction that major employers artificially impose is limiting the matching contribution that averages only 6%. The Solo 401k does not have this artificial employer matching limit.
To be clear, the IRS rules do say that you cannot contribute to a Solo 401k if you have full-time employees. But you can have part-time employees, you can hire contract employees, and your spouse can be a full-time employee. You do not have to match funds for part-time employees or contract employees. However, your spouse can contribute to a Solo 401k plan. You are going to like the answers that you learn by asking what is a solo 401k?
A biggie is that those artificial contribution limits made up by major employers go away. The IRS approved contribution limit for a Solo 401k increases based on inflation (typically annually). In 2021, the total Solo 401k contribution limit was $58,000. In 2022, it increased to $61,000 with a catch-up contribution allowance of an extra $6,500 for those 50 or older. That brings the 2022 contribution total to $67,500. If a spouse is also making maximum contributions, the combined annual contribution can be as high as $135,000.
The contributions are made in two parts. For some people, this works best by thinking of yourself as two separate people. You are the employer. And you are the employee.
As an employee of your own company, you make an employee contribution. In 2022, your employee portion can be as high as $20,500, or 100% of compensation, whichever is less. Those 50 or older get to contribute an additional $6,500. With a Solo 401k, you are in full control of your financial destiny. Annually, you can contribute as much or as little as you want, up to the full employee contribution amount.
Answers to the question what is a solo 401k get even better when you are your own employer and get to decide how much the employer contribution will be. The employer profit-sharing contribution can be up to 25% of your compensation (compared to the average 6% made by major employers). Or it can be your net self-employment income. Your net self-employment income is calculated as net profit minus half your self-employment tax and minus the contribution that you made as an employee. There is a $305,000 limit on compensation that can be used to factor the employer matching contribution in 2022.
It is the combination of both your employee and self-employer contributions that total $61,000 in 2022 or $67,500 if over age 50.
What is a Solo 401k, is still a good question if you have both a job with a major employer and work on the side. You can have separate 401k accounts with both. You can take the full profit-sharing contributions from both. However, your total employee contribution is limited to $20,500 plus the $6,500 for 50 or older in 2022. Only the employee contribution limit applies to contributions across all plans. The full employer profit-sharing contribution can be made by multiple plans.
What is a Solo 401k, if it doesn’t come with generous tax advantages? In fact, you get to pick the tax advantage that best fits your financial needs. You can have a traditional Solo 401k that makes contributions before taxes are calculated. These are tax-deferred contributions that you will not pay taxes on until retirement when you expect to be in a lower tax bracket. Also, all your earnings on those contributions remain in your Solo 401k tax-deferred until retirement.
Or you can choose the tax-free Roth Solo 401k. In this version, you pay taxes on contributions in the year earned. However, all the earnings are tax-free when withdrawn at retirement. You never pay taxes on these earnings. A Roth Solo 401k can be particularly attractive to younger people that can save a lifetime of earnings that remain tax-free forever. The Roth Solo 401k is also attractive to people that plan to retire wealthy and might be in a higher tax bracket during retirement.
What is a Solo 401k, if you can’t have your cake and eat it too? With Nabers Group, a Roth Solo 401k is included free with your traditional Solo 401k. You can contribute to either or both during any year. When you are self-employed with a Solo 401k, you have every option available to you!
Of course, if your spouse is also self-employed with the business, he or she have all the same options. Combined, both of you can double your employee and employer contributions. Each of you can decide between traditional tax-deferred contributions or tax-free Roth Solo 401k contributions. You are both in full control of your financial destiny!
What is a Solo 401k and Who Qualifies?
You may be surprised that there are only two IRS rules for who qualifies to open a Solo 401k.
- The presence of self-employment income (1099, side hustle, freelance, Schedule C, small business earned income, etc.).
- The absence of any full-time W-2 employees other than the owner and spouse.
The IRS has no profit threshold for a business with a Solo 401k. The business qualification is any legitimate business that operates with the intention of generating profits. The IRS also has no requirements for the level of contributions to a plan or how soon the business must begin to make a profit and contributions. Many sole proprietors with no formal business structure open a Solo 401k. As do people with a Limited Liability Company (LLC) or a partner LLC. If you have an S-Corporation or a C-Corp, these also qualify to open a Solo 401k.
Other small business retirement plans require including all full-time employees 21 and older and part-time employees who work more than 1,000 hours a year. However, a Solo 401k company can employ part-time workers (less than 1,000 hours per year) and independent contractors without making retirement contributions. The bottom line is that anyone who wants to be self-employed should be asking what is a solo 401k?
Who can Benefit From a Solo 401k?
The Solo 401k is perfect for sole proprietors, small businesses, and independent contractors. What is a solo 401k should be asked by self-employed people of all types. Examples include:
- Independent Consultants
- Real Estate Agents
- Professional service providers such as Attorneys, CPAs, Architects, and Medical Practitioners
- Financial Advisors & CFP’s
- Boutique Retailers without employees
- Internet-based sales or services businesses
- Physical Fitness Trainers, Coaches, or Therapists
- Child or Adult Care Providers
- And the list goes on.
Two of the most important benefits are:
- The higher contribution limits allow you to save more than with an IRA (about 10X more).
- You can invest in just about anything you want.
The many other benefits include borrowing from your retirement account, you can have business partners, there is no tax return for a Solo 401k plan (until $250,000 in total plan value – that only requires a 5500-EZ), and as your own trustee of the Solo 401k, you have complete control over your retirement assets. Nabers Group provides everything needed for the IRS to approve your Solo 401k plan. It’s a tax-efficient and cost-effective plan offering all the benefits of a Self-Directed IRA plan and includes many additional benefits.
How do you contribute to a Solo 401k?
The high contribution limits help you supercharge aggressive wealth growth. Just like your investments, you control your contributions. There are two ways to fund your Solo 401k:
Rollovers are the most common way to open a Solo 401k. Our unique Solo 401k software designs custom rollover and transfer packets for you to send to your previous custodian or administrator. Completing the rollover request and getting a customized rollover packet will take you 60 seconds or less, and you can initiate your rollover 24/7/365. Our customized rollover requests will contain information specifically for your rollover or transfer, including written instructions on how to complete the direct rollover into your new Solo 401k plan.
You can do a rollover from almost any other kind of retirement account including:
- Traditional IRAs
- Previous employer 401k plans
- Current employer 401k plans (if allowed – ask your current employer about this restriction)
- 403b plans
- TSP (thrift savings plans)
- KEOGH plans
- Defined Benefit Plans
- and more
The employee and employer contributions have been covered above. While learning what is a solo 401k, you will want to know who writes the check. The contribution is not made directly from the business bank account. After you get paid as the employer/employee of your business, you write the check for the contribution to the plan. Write a check payable to your Solo 401k trust. Write “Solo 401k contribution” in the memo section of the check. Then, deposit the contribution check into your Solo 401k bank or brokerage account.
Generally, the employee (salary deferral) contributions will appear on your W-2 form in box 12a that you issue in the role as your own employer. Your employer (profit-sharing) contributions will appear on Line 17 of IRS form 1120S for corporations or Part II – line 16 of Form 1040 Schedule 1 for sole proprietors. You only need to report the pre-tax (traditional) Solo 401k contributions. You do not report Roth Solo 401k contributions.
Have more questions about how contributions relate to your business? We’ve got answers:
- How to Rollover an Employer 401k to the Solo 401k
- How to Rollover Real Estate from the Self-Directed IRA to the Solo 401k
- Solo 401k Contribution Calculator
- Sole Proprietorships: Solo 401k Contributions
- Solo 401k Contributions for an LLC (single or multi-member)
- Partnership Contributions to a Solo 401k
- Solo 401k Contributions for a Corporation
- How To Successfully Complete Your Rollover
What are the Withdrawal Rules for a Solo 401k?
There are usually tax consequences if you withdraw funds from a Solo 401k before retirement. But there are ways that you can access your money early. A Roth solo 401k lets you withdraw contributions penalty-free that you have already paid taxes on — but not investment earnings. However, you cannot withdraw contributions exclusively. A portion of the withdrawal will be earnings. Therefore, at least part of your withdrawals will be subject to taxes and penalties.
Our article about 7 Ways to Get Money Out of the Solo 401k goes into detail about these common ways that funds can be withdrawn from your Solo 401k:
- Participant Loan
- Rollover to Another Retirement Plan
- Hardship Distribution/Withdrawal
- Early Withdrawal
- Normal Taxable Distribution
- Required Minimum Distribution
- Death Distribution
Setup Your Solo 401k Today
A Solo 401k plan is easy to set up, flexible, and can be funded with tax-deductible contributions up to $67,500, about 10X higher than an IRA. 2022 is the Year to Take Your Maximum Tax Savings. Setting up a Solo 401k is a powerful tax planning tool. Solo 401ks are fully compliant with all IRS rules. With Nabers Group, you can immediately begin investing in what you want. You are also ready to take full advantage of the 2022 tax benefits that come with your Solo 401k!
Take your retirement future into your full control. You worked hard for your money, and you deserve to control where it’s invested and grow as much as you want. Save big on taxes and invest with freedom using a Solo 401k.
Your financial freedom is waiting!
the IRS calls a one-participant 401(k) plan
IRS form 1120S
Form 1040 Schedule 1