Going Solo

By Ian Berger, JD
IRA Analyst
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Sometimes it pays to go solo.

For self-employed individuals looking to maximize their nest egg, a solo 401(k) plan — also known as an “individual 401(k)” or a “uni-k” — may be a better choice than a SIMPLE or SEP IRA.

Who Can Have a Solo 401(k)? Business owners can open up a solo 401(k) as long as they have no employees (other than a spouse). Solo plans are typically used by sole proprietors, but they are also available to owners of an incorporated business. If you’re self-employed and also earn salary as a regular employee of another business, you can still have a solo 401(k). But only your self-employment income can be taken into account in the solo plan.

How They Work. A solo 401(k) works mostly like a traditional 401(k). You contribute on a pre-tax basis, or if the plan allows, you can choose Roth contributions. Like a traditional 401(k), a solo plan can allow hardship withdrawals and/or loans. Distributions are allowed only after a triggering event (like separation from service, death or disability), but after a triggering event can be rolled over to an IRA.

The Big Advantage. The real advantage of a solo 401(k) stems from the fact that the IRS considers a business owner with a solo plan to be both an employee and an employer. This allows the owner to make elective deferrals (or Roth contributions) and deductible employer contributions.

Contribution Limits. There are separate limits on each kind of contribution. Employee contributions are limited to 100% of what the IRS calls “earned income”, but no more than $19,000 for 2019 ($25,000 if age 50 or older). Employer contribution limits are more complicated, but effectively work out to 20% of net self-employment income.  

There’s an overall annual limit on combined contributions, but that limit is very generous: $56,000 (or $62,000 if age 50 or older). Keep in mind that the elective deferral/Roth contribution limit is per person (not per plan). So, if you contribute to a solo 401(k) and a traditional 401(k), or to two or more solo plans, employee contributions to all plans are aggregated.

Administration. Solo 401(k) plans have traditionally been costly to open up, but with their increased popularity, administrative costs have come way down. Solo plans are exempt from IRS testing rules, and you don’t have to file a Form 5500 annual report with the IRS until assets exceed $250,000.

Solo 401(k) vs. SIMPLE or SEP IRA. A solo 401(k) may allow you to sock away more retirement savings than a SIMPLE or SEP IRA does. But comparisons between plans can be complicated, so you’ll definitely want to work with a financial planner or accountant – and not go solo – before starting up a solo 401(k).