A Solo 401(k) is specifically designed for self-employed people to save for retirement. It’s got some significant perks compared to other self-employed retirement plans. One benefit is that Solo 401(k) contribution limits are generally higher.
How Much Can I Contribute to My Solo 401(k) in 2022 and 2023?
One of the biggest advantages of a Solo 401(k) is that it has the highest contribution limit of any self-employed retirement plan. The contribution limit is up to $61,000 in 2022. And the limit goes up to $66,000 in 2023. On top of that, if you are 50 or older, you can make catch-up contributions of up to $6,500 in 2022 and $7,500 in 2023.
In a regular 401(k), the employer and employee make contributions. With a Solo 401(k), you play the role of the employer and employee and make contributions in each role.
Employee contribution: As the employee, you can contribute up to $20,500 in 2022 and $22,500 in 2023, or 100% of your compensation for the year, whichever is less. The catch-up contributions for those 50 and older applies here.
Employer contribution: As the employer, you can make profit-sharing contributions of up to 25% of your self-employment income. This amount is your business net profit minus half of your self-employment tax and the employer plan contributions you make for yourself (and your spouse if applicable).
If you’re married and your spouse draws income from your business, they can be covered by your Solo 401(k) – this is the only kind of employee covered.
The limit on compensation that can be factored into your tax year contribution is $305,000 in 2022 and $330,000 in 2023.
One thing to keep in mind, employee Solo 401(k) limits apply across all 401(k) plans. This is important if you’re side hustling on top of your full-time day job and making contributions to your 401(k). Contributions apply by person, not by each individual plan.
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How to Calculate Solo 401(k) Contribution
Again, there are two sides to your Solo 401(k) contributions: employee and employer. You make contributions from each role.
Employee contributions are the lesser of 100% of your compensation for the year or $20,500 in 2022 and $22,500 in 2023.
Calculating employer contributions is a little trickier. As the employer, you can make profit-sharing contributions of up to 25% of your net income from self-employment. To figure out your net earnings, it’s your net business profit less half of your self-employment tax and employer plan contributions you make for yourself and your spouse.
You can find your net income on your tax forms. For sole proprietors (what you are if you haven’t incorporated your business), you can find your net income on your tax Schedule C or C-EZ. If you’re an S-Corp, it’s your W-2 wages.
Tax-Advantaged Solo 401(k) Contributions
Besides the possibility of making a higher contribution than what other retirement plans allow, Solo 401(k)s let you make Roth or traditional contributions. Basically, you get to pick your tax advantage.
Traditional contributions are made with pre-tax dollars. They reduce your income in the year they’re made. Then, your disbursements in retirement are taxed as income.
Roth contributions are made with after-tax dollars. You pay taxes on this money before you contribute to your solo 401k, and your retirement disbursements aren’t taxed.
Generally, Roth contributions are better for people who think they will make more in retirement. But if you think you will be making less, traditional contributions will make more sense. Talk with a financial planner or accountant if you need help deciding between traditional or Roth.
Solo 401(k) Rules
Because of the tax advantage of a Solo 401(k), the IRS has fairly strict rules about when you can and must start taking withdrawals.
You can start taking disbursements from your solo 401k at age 59 ½ without any early withdrawal penalties. If you do take withdrawals early, the penalty is generally 10% of the withdrawal. There are very exceptions, but the IRS may waive the penalty in circumstances like:
- Medical expense that exceed 10% of your adjusted gross income
- Permanent disability
- Certain military service
- A Qualified Domestic Retirement Order (QDRO) issued as part of a divorce or court-approved separation
After you turn 59½ there are no penalties, and you must take your first distribution by April 1 of the year after you turn 72.
Spouse Contributions to Your Solo 401(k)
Next to a higher maximum contribution limit and being able to choose your tax advantage, another benefit of a Solo 401(k) is that your spouse can be covered by your Solo 401(k). Your spouse will have to draw income from your business for them to be eligible, but it means the two of you can potentially double your annual retirement savings.
As an employee, your spouse can make up to the $19,500 employee contribution limit. Then as the employer, you can make an additional profit-sharing contribution for your spouse, which again is 25% of compensation.
Your spouse is the only kind of employee that is eligible to use your Solo 401(k).
The Final Word on Solo 401(k) Contributions
If you’re self-employed, a Solo 401(k) may be a great solution to your retirement savings account needs. With contribution limits of $61,000 in 2022 and $66,000 in 2023, you can potentially stash more away than with other self-employed retirement plans.
Remember that your contribution limits apply by person, not plan. So if you’re also contributing to an employer 401(k) plan, the amount you can contribute as an employee to your Solo 401(k) is affected.
Yes, you can have more than one 401k. It’s something you might consider if you have a side hustle in addition to your full-time job. The thing you need to understand about having multiple 401ks is that the maximum employee contribution applies across all accounts.
So if you have a solo 401k and another employer 401k, you can contribute a total amount of $19,500. That could be $10,000 to one and $9,500 to another.
The eligibility requirements are pretty straightforward: you must be self-employed, have no employees, and must generate some form of self-employment income.
You can typically fit the first requirement if you’re a freelancer, sole-proprietor, business owner without any employees (although your spouse can contribute if they work for your business), or independent contractor. The second requirement, self-employment income, can be verified through tax records.
Your solo 401k must be established by December 31 to make contributions for that year. However, you have until your tax filing date to make both employee and employer contributions. The tax filing deadline is based on your self-employed business type. For example, the deadline for a sole proprietorship is April 15, and the deadline for an S-Corp is March 15.