If you’re looking at retirement account options, a solo 401(k) isn’t always on your radar. However, it could be a good choice for a range of professionals, suggesting you’re eligible to open one. If you’re curious about this retirement option, here’s everything you need to know about solo 401(k)s.
What a Solo 401(k) Is (and Who Can Have One)
A solo 401(k) is a type of individual 401(k) specifically designed for business owners or freelancers with employer identification numbers (EINs) that don’t have any full-time employees aside from a spouse. Functionally, it works a lot like a 401(k) through a company. However, there are both traditional and Roth variants, the latter of which isn’t always available if you’re an employee of a business.
You can have part-time staff, as well as work with freelancers, and still qualify. However, even one full-time employee at any point makes you ineligible.
Essentially, a solo 401(k) is an alternative to IRAs for self-employed professionals who are essentially one-person shows. It gives them access to different benefits and drawbacks, though, so it’s important to review those to decide if it’s right for you.
The Benefits of Solo 401(k)s
Solo 401(k)s are increasingly popular because the maximum contribution limit is much higher than what you’d find with an IRA. You’re able to make contributions for yourself and as an employer, letting you tackle saving from multiple fronts.
Exactly how much you can set aside in a solo 401(k) depends on your self-employed earnings and taxes. However, for 2021, you may be able to save up to $58,000 in a solo 401(k), not including catch-up contributions. For a traditional or Roth IRA, the limit is $6,000 ($7,000 if you’re 50 or older), while a SIMPLE IRA tops out at $13,500.
It’s important to note that SEP plan limits align with solo 401(k)s. However, those only allow contributions as the employer, not as the employee, so you’ll have a harder time reaching the maximum allowable amount.
When it comes to setting up a solo 401(k), the process is usually quite simple. If you have an EIN, many brokerages will let you open one without many headaches. But even if you don’t have an EIN, getting on is simple. You simply head to the IRS website, fill out a quick form, and you’re usually good to go.
On the tax side, you get to choose your preferred tax advantage. If you go with a traditional solo 401(k), you get tax benefits now. If you go with a Roth variant, you’ll get the tax perks once you retire and start making withdrawals.
Finally, you can include a spouse in a solo 401(k) if they also earn income from the business. Spouses are the only exception to the “no full-time employees” rule and, by adding yours, you could potentially double the total amount you can set aside from retirement when taken cumulatively.
Can you think of anything else people need to know about Solo 401(k)s? Share your thoughts in the comments below.
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Tamila McDonald is a U.S. Army veteran with 20 years of service, including five years as a military financial advisor. After retiring from the Army, she spent eight years as an AFCPE-certified personal financial advisor for wounded warriors and their families. Now she writes about personal finance and benefits programs for numerous financial websites.