Updated on 08/30/2022
[This post on the Solo-K is not financial, tax, nor legal advice, and the complete website disclosure statement can be found here. All contribution limits mentioned are of 2022. If you are unsure if your situation qualifies, I suggest you talk to the respective professional in that field for clarity.]
401(k)s Should Be For Everyone
The 401(k) is perhaps the most powerful retirement savings account the US tax code offers. Want to save with tax-deferred contributions? No problem. Roth? Absolutely. Need to take a loan? Go for it. Unlimited creditor protection? Ask no more, the 401(k) provides.
However, 401(k) plans have one major caveat: You must work for an employer that offers one, and strikingly, as of 2021, this only accounts for 52% of the workforce. (No figure is available for 2022.)
So, what if we could increase participation in this powerful account? Well, the answer would be that a more significant number of people would achieve their financial goals!
Therefore, guess what? We can. It is party time!
Enter The Solo-K
Are you a gig-worker, self-employed, or a hustler? Then you are your employer! Thus, you can contribute to a solo-k plan, i.e., a Solo 401(k)!
Do you work for another company that pays you a W-2 wage? That doesn’t matter, and you can still open a Solo 401(k) if you have a seperate 1099 income.
Quick Definitions To Know
Solo = Individual = Self Employed (SE) = One Participant
K = Subsection K of section 401 in the tax-code
W-2 Income = Employee of a firm, receive benefits
•If you receive a W-2, you are an employee. Period.
1099 Income = Self-employed or independent contractor for a firm, likely receive no benefits other than a check
•If you receive a 1099-MISC, 1099-K, or 1099-NEC at year-end, you are almost certainly a contractor. However, if you are unsure, always talk to an accountant.
Suddenly The Gates Open
With the rise of the gig economy and the increased prominence of side hustles, nearly everyone should be able to contribute to a 401(k) plan if they want in 2021.
Thus, the gates of the 401(k) are now open to the masses!
It Is All About The Benefits
What are the main benefits of 401(k) plans, specifically self-employed ones? Well, they include¹:
•Tax-deferred or Roth contributions up to $20,500² in 2022
•Catch-up contributions up to $6,500² for those 50+
•Profit sharing contributions up to $61,000³
•Unlimited creditor protection at the Federal level
•No income limits or phase-outs, even for high earners
•Ability to take loans against the 401(k) balance
•Ability to invest in various securities (stocks, bonds, ETFs, mutual funds, physical real estate, etc.)
•Access to Mega backdoor Roth contributions and conversions
•Access to Roth conversions & ladders
Important Disclosures To Note
1. Just because the IRS allows for a feature doesn’t mean a sponsor has to enable it. All benefits above depend on the plan sponsor (i.e., the company you open the plan at). Popular sponsors, which I have no affiliation with, include Solo 401k by Nabers Group, TD Ameritrade, and Fidelity Investments.
2. You can only contribute up to the amount you make from your self-employed income for employee or employer contributions. Example: Your side hustle generates $15,000 a year; you can only contribute $15,000 to a Solo 401(k). If your self-employed income exceeds $20,500 (and the additional $6,500 for those 50+), you are capped at the limits ($20,500 and $6,500, respectively).
3. Since you are the employee and employer, you can make contributions as both. Thus, once you reach the $20,500 limit, you can make a profit-sharing contribution on a pre-tax or after-tax basis¹ of up to 25% of business net-profits or $61,000⁴, whichever is less.
4. The $61,000 limit is for the employee and employer combined. So, if you contribute $20,500, you can contribute $40,500⁵ as a profit-sharing contribution. Catch-up contributions of $6,500 are in excess of the $61,000 limit. Thus, the overall compensation from self-employed income that can be placed into a Solo 401(k) is $67,500.
5. Your business structure (sole proprietorship, single-member LLC, S-Corp) affects contribution limits. Check with an accountant, read an online guide, and or use an online calculator if you are unsure how much you can contribute. Remember, using an accountant is a sure-fire way to ensure accuracy!
What If I Already Have A 401(k) At My W-2 Job?
What if you happen to fall into the above category, where you are part of the 52% that has access to a 401(k) at work? That is okay; you can still contribute to a Solo 401(k). However, the employer and employee contribution limits of $20,500, $6,500, and $61,000 are shared across all 401(k) plans.
Thus, if you reach the $20,500 limit at your W-2 job, you cannot make an employee contribution to your Solo 401(k). But, you can make an employer contribution, as long as it doesn’t put you above the $61,000 limit with any company match, profit sharing, and other compensation that went into your W-2 and Solo 401(k) plans combined.
Confusing, I know. Just remember all 401(k) plans share the same limits each year! So never exceed the respective limits when you add all contributions together from all employers.
What Will You Do?
Now you know the secret, so the world is your oyster. Go out there and save!
Do you have a side income? If so, have you considered using a Solo 401(k) plan? Let me know in the comments below, and as always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time
401(k) is nice but many people do better with a pension.
I wish pensions were as common as they used to be in the United States. Nowadays, they seem to be only given by legacy companies. For example: UPS and Shell
So, if you cannot bank on a pension, the burden of generating retirement income falls on you.