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Updated Nov 08, 2023

Self-Employed 401(k) Plans: Frequently Asked Questions

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Heather Larson, Business Operations Insider and Senior Writer

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The number of people who run their own business continues to trend up, but working for yourself means you are responsible for your own retirement plan. Fortunately, there are several retirement plan options available to independent workers. One of the most popular retirement plans for independent workers is a self-employed 401(k). 

You can contribute a large amount of money to this plan every year and then start taking distributions from the account after you turn 59.5 years of age. The first step in opening a self-employed 401(k) plan is to select a provider that meets your needs. We spoke to two financial experts to find out how these retirement plans work.

Logan Allec, CPA and owner of the personal finance site Money Done Right, and Adam Bergman, a trained tax attorney and president of IRA Financial Trust and IRA Financial Group, offered their insights about these plans, including the maximum contributions, taxes, investments and fees.

Editor’s note: Looking for the right employee retirement plan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.

What is a self-employed 401(k) plan?

This plan goes by many names, including solo, individual and single-k, but they all refer to a 401(k) retirement savings plan for a self-employed person. You can contribute a large amount of money to this plan every year and then start taking distributions from the account after you turn 59.5 years of age.

Key TakeawayKey takeaway

A self-employed 401(k) plan is a retirement savings plan started and contributed to by a self-employed person.

What is the best retirement plan for a self-employed person?

Allec says that, for most businesses, the solo 401(k) is the best option. Many small businesses can contribute more to a solo 401(k) than, say, a SEP at the same income level. With an IRA, you can contribute only $6,000 (younger than 50 years old) or $7,000 (50 years or older) in 2022. With a SEP IRA, you can’t contribute as both employer and employee, only as an employer.

There are several other types of retirement plans besides self-employed 401(k)s. These include the following:

  • Traditional IRA: This retirement account allows you to grow investments tax-deferred. This means that once you retire, you pay income tax on your withdrawals, but you don’t pay taxes on your investments beforehand. Additionally, your IRA contributions may be tax-deductible. 
  • Roth IRA: This retirement account includes not only tax-free investment growth, but also tax-free withdrawals in retirement. However, unlike with a traditional IRA, you pay taxes on the money you invest, and your investments are not tax-deductible. 
  • Simplified Employee Pension (SEP) IRA: Like a traditional IRA, a SEP IRA has tax-deferred investments and distributions taxed as income during retirement. However, unlike a traditional IRA, only business owners – including self-employed people – can open them. You can add up to 25% of your annual self-employment earnings to your SEP IRA. 
  • Savings Incentive Match Plan for Employees (SIMPLE) IRA: This retirement account facilitates employee and employer matching contributions to a traditional IRA. The IRS also allows self-employed people to use these plans – as a self-employed person, you are both the employer and employee. All your annual self-employment net earnings qualify for addition to your SIMPLE IRA.

Summary: The solo 401(k) is the best retirement plan for a self-employed person, but traditional IRAs, Roth IRAs, SEP IRAs and SIMPLE IRAs remain options.

Self-employed retirement plan FAQs

Now that you understand solo 401(k)s and know they are the best – but not only – retirement account option for self-employed people like you, you may have other questions about your retirement plan. Allec and Bergman shared their perspectives on some frequently asked questions about self-employed retirement plans.

Who can have a solo 401(k) plan?

According to Allec, there are three categories of people who can have solo 401(k) plans:

  1. You’re required to make self-employment income from your personal efforts; usually, you generate a product or provide a service. You could also provide services as an independent contractor, like driving for Uber or working on a 1099 basis for a company.
  2. A sole proprietorship, limited liability company (LLC), S corporation, C corporation and limited partnership can all set up an individual 401(k).
  3. Your business can’t employ any full-time workers besides yourself.

Can you have employees and open a single-k?

You can’t have any full-time employees, but you can contract with freelancers or employ part-time employees who don’t work more than 1,000 hours per year for your business. Note that not all individual 401(k) plans allow for part-time employees, so be sure to check with your provider before hiring employees.

How do you start one of these 401(k) plans?

Bergman says you first need to select a provider. One of the most common ways to establish one of these plans is to go through a bank. You usually aren’t charged a fee for these, but your investment options are limited to the financial products the bank or financial institution sells. You can also go through a brokerage. In addition, there are self-directed solo 401(k) plan document providers, which do not sell investments and will allow you to establish a self-directed solo 401(k) plan to make alternative asset investments, such as real estate, as well as gain access to all other available plan options, such as Roth contributions and a $50,000 loan option.

When should I start a self-employed 401(k)?

Bergman says to start early – the younger, the better – and be consistent. Whenever you can, you want to defer taxes instead of paying taxes. You also want to maximize the amount of money you’ll have in retirement.

How much can you contribute to an individual 401(k)?

According to Allec, the contribution limits have both an employee and employer component. You fill both those roles. In 2022, an employee can contribute up to $20,500 if they are under 50. For those 50 or older, the maximum is $27,000. The $6,500 difference is a catch-up provision, meaning older individuals can save more for their retirement.

As for the employer component, you can make a nonelective (tax-deductible) contribution to the 401(k) of 25% of your Form W-2 wages. For example, if you earn $100,000 in wages in 2022, you can contribute $20,500 as an employee and $25,000 (25%) as an employer for a total of $45,500. For a sole proprietorship, the employer component is 20% of your net income from self-employment, which is calculated as your self-employment income as reported on Schedule C, less your deduction for half of the self-employment taxes paid.

When you contribute as both an employee and an employer, the threshold amount in 2022 is $61,000 if you’re under 50 and $67,500 if you’re 50 or older.

These limits usually change every year, and typically they go up to adjust for inflation. The increase is usually a round number, not a percentage.

If your spouse works for your business and is compensated, they can participate in your business’s solo 401(k) at the same limits as above.

Can you contribute a lump sum to a self-employed 401(k)?

According to Bergman, a self-employed individual can usually make an employee deferral lump-sum contribution to a plan so long as they have sufficient earned income.  However, in the case of a W-2 owner/employee, the employee deferral contribution should not be more than the income earned for that income period. In the case of employer profit-sharing contributions, those can be made by the employer in a lump sum.

How does the money grow in a self-employed 401(k)?

Bergman says that depending on the provider you choose to house your plan, you can invest in almost anything. However, if you select a financial institution to oversee your plan, you must invest in their products. Otherwise, opportunities remain limitless. Go the traditional route with stocks or mutual funds, or turn to alternative investments like real estate, gold or cryptocurrencies.

What fees are associated with a solo 401(k)?

Account maintenance fees for these plans, according to Allec, usually run between $20 and $200 per year. You’ll pay the least if your needs are simple – you don’t have any employees besides yourself, there’s no rollover and you’re OK with investing in a budget brokerage firm’s products. If you have a more interesting investment appetite, another provider can accommodate those. These providers usually charge higher fees to maintain your plan, but you also have more flexibility with your investment and plan options.

Is a solo 401(k) tax-deductible?

Yes. By using your business funds to contribute to your 401(k), you’re eligible to claim a deduction for the cost of the plan and its maintenance fees. This helps reduce your business’s income tax obligation.

Can I withdraw funds penalty-free from this plan?

Bergman said you can borrow from your 401(k) up to $50,000 or 50% of the account value, whichever is less, for any purpose at a low-interest rate. To avoid taxes, this loan must be repaid within five years of the loan date, and payments must be made at least quarterly.

How long do you have once a previous 401(k) is terminated to roll those funds into a new solo 401(k)?

According to Bergman, once the decision is made by the business to terminate the plan, the plan participant will generally have to move those funds during the course of the tax year, but it really should be done as soon as reasonably possible.

What are the most common mistakes people make with self-employed 401(k) plans?

Overcontributing, in Allec’s opinion, is the largest mistake. When you discover you’ve put too much money into your plan, call your provider right away. They can help you withdraw the overcontributed amount so you won’t have to pay taxes on it.

Another common error is breaking one of the prohibited transaction rules. For example, your plan buys a house in Florida and rents it out as an investment. If you want to take a family trip to Disney World, you can’t stay in that house. Once you’ve invested in alternative assets and break the rules, you will be subjected to taxes and penalties. Always make sure your provider goes over the rules with you when you open your individual 401(k).

The last mistake many people make is not getting their solo 401(k) set up by the end of the year.

Self-Employment Doesn’t Stop You From Saving

Data released by the U.S. Bureau of Labor Statistics showed that in 2022, just under 10 million people in the U.S. are self-employed. If you count yourself among them, an individual 401(k) plan can help you prepare for your retirement. Assess your current and future needs so you can choose the right provider and begin saving.

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Heather Larson, Business Operations Insider and Senior Writer
Heather Larson spent way too many years working in different finance departments. Now she writes about money along with business solutions and technology. When she's not writing, she relishes reading a good thriller with her rescue dog in her lap.
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