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How to Save for Retirement When You’re Self-Employed: Solo 401(k)s Explained

Ryan Robinson Writer, entrepreneur, and small business consultant 
a self employed business owner at work in a colorful office

Working for yourself—whether as a freelancer or small business owner—has many perks. But there’s one area solopreneurs need to be careful not to overlook—saving for retirement.

It’s one of the most important decisions anyone can make for their future, yet nearly 50% of Americans approaching retirement have little to nothing in their retirement savings accounts.

As a full-time employee, saving is somewhat automatic as both you and your employer can contribute to a retirement plan like a 401(k). So as a self-employed business owner, what should you do about your retirement goals?

This question is one I’ve grappled with myself for many years—and it’s not an easy one to answer.

I’d always been diligent about tucking away a meaningful portion of my monthly income into savings, but pretty early on, my accountant convinced me that’s not enough. To safely set myself up for retirement one day, I needed to start investing in a self-employed retirement plan.

Based on my research and experience as a solopreneur, I believe the solo 401(k) can be an incredible way to help self-employed folks save for retirement.

The question is, where do you even start? Before we rush into the details of setting up a self-employed retirement plan, let’s quickly look at what a solo 401(k) is and how it can benefit your retirement savings. 

What is a solo 401(k)? 

A solo 401(k), also called an individual 401(k), is a 401(k) plan tailored specifically toward business owners with no employees—also known as solopreneurs.

Like all 401(k) plans, the solo 401(k) is also a tax-qualified, defined-contribution retirement savings account that’s deducted before taxation (therefore tax-deferred until withdrawn after your retirement) and limited to a maximum pre-tax annual contribution of $57,000 (for the year 2020).

While you can’t contribute to a solo 401(k) if you have employees in your business (that isn’t you), you can use this type of retirement account to cover contributions for both you and your spouse.

And if your business entity is a type of partnership, each shareholder is also eligible to contribute to a solo 401(k) retirement plan for themselves.

What else should you know about the individual 401(k)? Here are a few key facts and features to help you fully evaluate this investment option and take a meaningful step towards saving for retirement—the solo 401(k) way.

Rules for a solo 401(k)

To qualify for a solo 401(k), you’ll need to meet a few requirements. The two biggest solo 401(k) rules say that you:

  • Must be earning self-employed income
  • Must not have any employees working 1,000 hours or more annually

There are no age or income restrictions, so anyone can sign up for a solo 401(k) plan—as long as you’re running a registered self-employed business—including a sole proprietorship, an LLC, partnership, C corporation, or S corporation.

The 2 types of solo 401(k) plans

When investing in a solo 401(k) plan, you’ll have to choose between one of two plans:

  • Self-directed solo 401(k). With this more hands-on option, you can determine the types of investments you want to channel your retirement savings into. This could be anything from real estate to private companies or even more exotic investments like cryptocurrencies. You also get the option to elect for a Roth contribution, in which you can contribute post-tax income through your self-directed solo 401(k). Ultimately, a self-directed solo 401(k) gives you more flexibility in your investment options, but comes with the need to make more regular management decisions.
  • Brokerage-based solo 401(k). A brokerage-based plan on the other hand, is much less involved in the actual investment decision-making process. You’re limited in terms of the investment options available (compared to a self-directed plan), to things like stocks, mutual funds, and other market-based assets. However, this avenue tends to be more popular with younger business owners that aren’t interested in actively managing the individual asset allocations within their retirement investment plans.

So which type of solo 401(k) plan is best for your needs?

Well, that all boils down to your experience with investing, understanding of the market and the amount of time you’re willing to allocate to managing your funds.

If you have the knowledge, experience, and desire to be hands-on with your investments, then a self-directed solo 401(k) plan can give you more opportunities to grow your retirement savings at a quicker pace—but with more potential risks.

If you’re more concerned with the growth of your primary business and would rather put your self-employed retirement savings on autopilot, you’re probably better off with a brokerage-based plan that can grow your savings at a more conservative, traditionally less risky rate behind-the-scenes.

Why should I consider a solo 401(k) when I have so many other business expenses? 

If there’s one thing all small business owners—particularly solopreneurs—have in common, it’s the fact that expenses often eat up a lot of your hard-earned income. For this reason, many small business owners don’t invest in a retirement plan (or wait far too long), as it piles onto the already back-breaking expenses many have to shoulder.

But is that really the best way to think about planning for retirement?

Let’s flip this around. Challenge yourself to answer some difficult questions to figure out where retirement saving should sit amongst your various priorities:

  • Even if you love what you do today, do you want to work for the rest of your life?
  • At what age would you like to start working less, or even fully retire?
  • How much do you expect to want in savings to retire comfortably?
  • Does it look realistic to hit your retirement savings goal on time, if you start today?
  • If not, can you restructure how your business functions to save more now?

Even these foundational questions assume that everything goes according to plan.

What if something unexpected happens either in your business or personal life?

The goal isn’t to try and plan out the nuances of your next several decades, but these are big questions that every entrepreneur should be thinking about (and answering) for themselves as early as possible. It’s never too early to start planning for retirement as a business owner.

Plus, the more you begin setting aside for retirement early on in your self-employed career, the more time your investment has to grow and compound over the years to come—making it easier to retire once the time is right.

So, is it better to make some sacrifices today and begin planning for your retirement with a solo 401(k)? To fully answer this question, let’s briefly look at some benefits of taking out an individual 401(k) plan.

Easy to administer

As a solopreneur, it’s normal to wear many different hats to ensure that your business runs smoothly. Because of this, you probably don’t need to add any more unnecessary headaches to your to-do list.

Unlike the regular 401(k) that has annual (and often complicated) filing requirements, the solo 401(k) is extremely easy to administer on a yearly basis.

  • There are no annual filing requirements as long as your plan doesn’t exceed $250,000 in assets. 
  • Once your plan does exceed that limit, you’re only required to file a short, two-page information return (Form 5500-EZ) with the IRS each year along with your tax return. 

Allows you to borrow against the account

A solo 401(k) account lets you borrow up to 50% of your account value, or a maximum of $50,000, whichever comes first—against the remaining balance of your plan. You can use this cash for any purpose.

As a bonus, these loans come at a low interest, prime rate plus 1%, which is just about the lowest interest rate banks will lend to their most favored customers—making this a very inexpensive loan.

Many people use these low-interest rate loans to pay off personal or business debt that’s currently accumulating a higher interest rate, therefore moving their debt to the lower interest rate on the loan against their solo 401(k) plan.

Before deciding to take out a loan against your Solo 401(k), it’s smart to consider your potential loss of investment returns for the coming months or years—especially if your plan has been yielding high returns.

Enticing tax benefits

Because solo 401(k) plans can include a Roth option, contributions can be made on an after-tax basis. Unlike other pre-tax contributions, you won’t have to pay an upfront tax deduction.

This means the distribution of Roth 401(k) contributions, as well as any earnings, are 100% tax-free.

With all of these benefits (and many more below), a solo 401(k) plan is a great retirement plan option for self-employed business owners.

How much can you save for retirement in a Solo 401(k)?

Individual taxpayers that earn more than a certain amount ($137,000 for singles or $203,000 for married couples in 2019) can’t contribute to a traditional Roth IRA-based plan due to income restrictions.

However, there are no income restrictions on contributing to a solo 401(k) plan.

One of the main advantages of a solo 401(k) plan is that the contribution limits are some of the highest out of all types of retirement plans. This is especially true when considering that as a self-employed contributor, you wear two different hats—one as an employer and also that of an employee of your business.

And the best part? You can make contributions as both the owner and employee.

Contribution limits for solo 401(k) plans in 2020

Employee Limit:$19,500
Employee Catch-up Limit (if Over 50 Years of Age):$6,500
Employer Limit:Up to 25% of Total Compensation

* The total solo 401(k) contribution limit in 2020 is a maximum of $57,000. If over the age of 50, the contribution limit increases to $61,000 to allow for catch-up contributions.

In 2020, the solo 401(k) contribution limit for employees is $19,500. If you’re 50 or older, you’re also afforded a catch-up contribution of $6,500, bringing the total up to $27,000.

As the employer, you’re allowed to contribute up to 25% of your total compensation.

However, there is a total contribution limit (in 2020) for a solo 401(k) which caps you at $57,000 per year. That’s not counting the $6,500 catch-up contribution if you’re 50 and over though, which can bring your total annual contribution up to $63,500 per year once you’re over 50.

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The solo 401(k) vs SEP IRA (and other self-employed retirement plans)

I know what you’re thinking—with so many retirement plan options out there for the self-employed, why should you opt for a solo 401(k) over all the rest?

Well, let’s quickly look at how it compares to other retirement plans that are available to self-employed business owners. This will give you a crystal-clear picture of your options, which will help you make a more informed decision.

Solo 401(k) vs SEP IRA

SEP IRAs (Simplified Employee Pension Individual Retirement Arrangement) have been the most popular retirement plan for solopreneurs and small business owners for a long time.

A SEP IRA allows you to contribute a sizable chunk of money to your retirement plan, while reducing your tax bill at the same time.

So what’s the difference between a solo 401(k) and a SEP IRA?

Solo 401(k) retirement plansSEP IRA retirement plans
2020 contribution limit:  $57,0002020 contribution limit:  $57,000
Min. Annual Income to Hit Limit:  $148,000Min. Annual Income to Hit Limit:  $224,000
Allows for Catch-up Contributions? YesAllows for Catch-up Contributions? No
Allows for Low-Interest Loan: YesAllows for Low-Interest Loan: No
Allows for Roth Option? YesAllows for Roth Option? No
More Diverse Investment OptionsLess Diverse Investment Options

Contributions limits

With a SEP IRA, contributions are made solely by your business, whereas with a solo 401(k), you can contribute both as an employer and employee. This means you can reach your maximum contribution faster with a solo 401(k).

In short, if you earn less than $224,000 per year from your business, you can contribute a greater share of your total income to a solo 401(k) retirement plan than you can with a SEP IRA.

Here’s how the math works out:

For the 2020 calendar year, the maximum contribution toward a SEP IRA plan is $57,000. However, contributions to a SEP IRA can’t exceed 25% of the compensation you get from your business during the year, making it more difficult to hit that limit—unless you have an annual income that exceeds $224,000.

With a solo 401(k), only the employer portion of your contribution is restricted by the limit of setting aside up to 25% of your compensation. The employee portion of a solo 401(k) plan allows you to contribute up to $19,500 for the year.

Add each of these two contributions together, and you can max out your entire contribution of $57,000 for the year (if you’re under the age of 50) on an income of $148,000.

Catch-up provisions

One of the biggest benefits of the solo 401(k) over the SEP IRA and other retirement plans for solopreneurs, is that it allows for catch-up contributions from investors above 50 years of age.

Other differences between a solo 401(k)and a SEP IRA are:

  • A solo 401(k) allows you to take out a low-interest loan while a SEP IRA doesn’t
  • A solo 401(k) has a Roth option (ability to contribute post-tax income) while a SEP IRA doesn’t allow for Roth contributions
  • Investment options are more diverse with a solo 401(k) than with a SEP IRA

One common feature of both retirement plans is that they allow you as the business owner to contribute up to 25% of your business profits to the retirement plan.

With the solo 401(k) though, you’re also permitted to contribute up to $19,500 (or $25,000 if you’re over the age of 50) as the employee of your business—making it a much more savvy choice.

Solo 401(k) vs SIMPLE IRA

The Savings Incentive Match Plan for Employees, commonly referred to as a SIMPLE IRA, is a retirement investment plan that’s similar to a solo 401(k) in many ways, but doesn’t quite stack up at the end of the day.

For example, take these major differences (for 2020) into account:

Solo 401(k) Retirement PlansSIMPLE IRA Retirement Plans
Employee Contribution Limit:  $19,500Employee Contribution Limit:  $13,500
Employer Contribution Limit:  Up to 25% of Annual IncomeEmployer Contribution Limit:  Matching (Up to 3% of Annual Income)
Catch-up Contribution Limit:  $6,500Catch-up Contribution Limit:  $3,000
  • Both allow you to contribute as an employer and employee. However, the contribution limits for a SIMPLE IRA are much lower than those of a solo 401(k). With a SIMPLE IRA, you’re capped at an employee contribution limit of $13,500 per year (in 2019)—and an employer contribution limit that’s required to match what you contribute as an employee, up to a maximum of 3% of your total compensation from your business.
  • Both allow catch up contributions for those over the age of 50. That being said, the SIMPLE IRA catch-up contribution limit ($3,000) is merely half of the $6,000/year catch-up contribution limit for the Solo 401(k). 

Given these factors alone, the solo 401(k) emerges as a much better option for self-employed business owners hoping to contribute more to their retirement plans each year.

Solo 401(k) vs IRA (Traditional and Roth)

A traditional or Roth IRA is one of the easiest retirement options to set up if you’re self-employed, especially since there are no special tax filing requirements.

One of the biggest advantages of an IRA is that you can use it whether you have 10 employees or zero—so it can remain in place even as your business grows.

Let’s quickly compare the main features of a self-employed IRA to a Solo 401(k), to help you decide which will be a better option for your future plans.

Contribution limits

The maximum annual contribution limit for an IRA is $6,000 (or $7,000 for those age 50 and older) in 2020. While this is drastically lower than the $57,000/year contribution limit on a solo 401(k), it might be enough of a start for those just getting their businesses off the ground.

Catch-up provisions

IRA retirement investments have an annual catch-up contribution limit of $1,000 for those over the age of 50. Again, this is much lower than the $6,500/year catch-up contribution cap you’re afforded with a solo 401(k).

Tax advantages

If you opt for the traditional IRA, you get a one-for-one tax deduction (also called a tax break) in the year your contribution is made. Keep in mind that this means your distributions in retirement will be taxed as ordinary income, which isn’t great.

Opting for the Roth IRA, on the other hand, doesn’t give you any immediate tax breaks. You’ll pay taxes this year on the contribution you make to your Roth IRA. However, your distributions once in retirement will be tax-free.

So which is the better retirement plan option for your self-employed needs?

When comparing the solo 401(k) to both self-employed IRA investment options (traditional and Roth), you’ll discover that a solo 401(k) may actually give you the best of both worlds.

Since you can contribute dramatically higher amounts and determine the tax advantages that suit you best, it becomes a no-brainer—going with a solo 401(k) is likely the better option for a self-employed business owner’s long-term retirement savings.

Now you’ll just need to decide between a traditional solo 401(k) (where your contributions aren’t taxed until they’re withdrawn in retirement), or a Roth solo 401(k) that takes taxes out today—and gives you tax-free withdrawals in retirement.

How to pick the best solo 401(k) provider for you

Now that you know what a solo 401(k) is and why you need it, let’s quickly look at a few factors to guide you in selecting the best solo 401(k) provider for your needs.

While many companies offer solo 401(k) plans, not all plans are created equal. It’s important to do your homework upfront so you can pick the best solo 401(k) provider.

To get you started, a few of the most established and popular solo 401(k) providers include:

These are just a handful of the highest-rated solo 401(k) providers that offer affordable management of self-employed retirement plans. They also include the ability to make customized adjustments with a broker based on your own unique financial and retirement goals.

As you’re evaluating the Individual 401(k)s each of these companies have to offer, consider everything from the firm’s expertise, to how flexible the plan will be, the annual fees (plus longer-term costs) and more. These details are all in the plan descriptions, or if you request further information from a representative at the firm.

Experience and expertise

Two of the biggest factors to consider when picking a solo 401(k) provider are the track record and knowledge of the company you’re choosing to invest with—assuming you’ve opted for the brokerage-managed route that doesn’t require a hands-on approach.

Investing in your retirement is one of the most important steps you can take to safeguard the future for yourself, your family, and your business.

For this reason, my recommendation is to choose a reputable and well-established solo 401(k) provider that’s already administered this type of retirement plan for business owners like yourself.

Another reason to make expertise one of the most important factors to guide you, is that IRS compliance regulations, contribution limits, and reporting requirements are always changing. This makes it difficult for novice investors (or self-directed plan owners) to navigate this environment.

However, a service provider that has both experience and expertise can easily handle these changes and offer you the best ongoing service.

Flexibility  

Another factor to consider when shopping for the best solo 401(k) provider for your situation, is flexibility. This is important as not all solo 401(k) plans are the same.

A few questions you should ask when picking a solo 401(k) plan, include:

  • Does the plan offer Roth and Traditional contributions? Not all solo 401(k) plans come with Roth/Traditional contribution options, so make sure you get one that allows for both contribution types if you want to give yourself maximum flexibility in your investment decisions (with the least hassle) for the years to come.
  • What types of investment options are available in the plan? Different solo 401(k) providers offer different investment options. Of course, the more versatile the options you get to choose from—based on your risk tolerance and financial goals—the better the plan will be for you.
  • Historic returns. Does the investment firm you’re considering have a track record of strong performance in the market? If they’re prone to tumultuous returns from year-to-year, keep in mind that your retirement savings will soon be riding that wave too.
  • Rollovers. Not all solo 401(k) plans allow rollovers into and out of a plan. This limits your options significantly if you want to switch to a different investment strategy (or provider) at some point down the road.
  • Loan provisions. While it’s not often advisable to take out a loan from your retirement plan, there are times when it can be useful. For instance, some seasoned business owners might need access to quick capital in order to fund dependable growth beyond what cash reserves can cover.

Each of these features of a solo 401(k) plan will be extremely important to consider and compare, as they determine the kinds of retirement benefits you’ll enjoy from your plan.

Cost

Of course, when deciding on a self-employed retirement plan, another key consideration is the cost. All retirement plans typically come with two main expenses:

  • Cost of investing in the plan. Upfront fees that you’ll incur when opening a retirement account with the investment firm. While setup fees can vary widely (and some investment firms don’t charge them at all), most one-time starting fees range between $20 to $150.
  • Cost of maintaining the plan. Ongoing fees, commissions, and performance-based payouts to the investment firm managing your retirement plan. Monthly fees for maintaining your plan can also vary widely, but typically range between $2 to $30 per month (note that some investment firms opt to instead only charge transaction fees or percentage-based expenses). Be sure to read the fine print carefully before committing to a plan.

Keep in mind that many investment brokers offer “free” solo 401(k) plans, but I’d recommend staying away from them. These are usually very limited in the investment options at your disposal, as these types of plans are designed more or less as a way to introduce you to their firm—and open the door for additional business.

What happens if I hire employees and want to offer them a 401(k) too?

If there’s one thing every business owner looks forward to, it’s growth. But with that business growth, comes responsibilities—especially when it comes to employees.

So what do you do when your business grows and you’ve got full-time employees who need a retirement plan?

As you’ve already seen, a solo 401(k) is a one-participant 401(k) plan that can’t be revised to include your employees. When your business grows, you’ll need to move to a more inclusive retirement plan.

While this may seem like a complicated step to take, it’s actually very simple. Especially if you partner with a 401(k) service provider like Guideline through Gusto, where you can sync your payroll to your 401(k), making this next big step much easier.

Should I consider an employer-sponsored 401(k) plan?

While this is certainly a business decision that should be fully evaluated with an accountant or financial professional, the positive mutual benefits of offering a 401(k) plan to employees have proven to be somewhat substantial.

1. It helps you attract and retain talented employees.

Hiring the right employees to help grow your business is difficult. Retaining that talent is even harder. This is why, as a small business owner, you should consider offering a competitive retirement plan to ensure your team sticks around.

In fact, studies have shown that employees who value retirement plans are 2.5X more likely to stay with an employer who offers an attractive, well-managed 401(k) plan.

2. It helps maximize savings for both your business and employees.

Let’s be honest—the IRS can be rather demanding when it comes to your tax obligations as a business owner (and employer).

One way of maximizing your tax savings for you and your employees is by enrolling in a retirement plan that allows you to fully utilize the tax benefits of saving for retirement.

3. Help your employees retire with less stress.

One of the greatest causes of stress among Americans is thinking about retirement, especially for those who have no retirement plan in place.

Helping your employees invest in their own retirement, even if it’s far off into the future, is a great way to improve the quality of their life after work.

Offering a 401(k) plan, and then an employer match on top, is a great way to motivate your employees to invest even more into their retirement plans. It also gives them yet another incentive to stay with your company.

How to get started with a 401(k) plan for small businesses

Before you rush off and sign up for a 401(k) plan, here are a few factors you need to consider in order to get the most out of your retirement plan.

1. Decide on the type of 401(k) plan you’ll offer.

With many different retirement providers and plans available to small business owners, you’ll need to find the one that suits both you and your employees the best.

If you already use Gusto for your payroll services and benefits administration, then adding an industry-leading 401(k) plan for both you and your employees, is as easy as flipping a switch.

2. Determine how much you want to contribute.

After deciding on the 401(k) plan that suits your needs, the next step is to look at the costs involved in setting your plan up—and keeping it going for the months (and years) to come.

You’ll have to determine how much you can afford to contribute—not only to your own plan, but also how much you can match for your employees’ plans, if that’s the route you want to go.

Be sure to consult with your accountant or financial advisor to land on an offer that makes sense for both your future business and personal goals.

3. Pick the best 401(k) provider for you.

As a small business owner, setting up a 401(k) can be a rather overwhelming endeavor. 

That’s why it’s important to enlist the help of a reliable and reputable 401(k) provider to help you navigate the complex waters of retirement savings. 

Saving for self-employed retirement is a must

Regardless of whether or not you have employees, as the owner of your own business (and the owner of your destiny), it’s essential for you to plan for your future retirement.

Seriously consider your options now—because the best time to start saving for your retirement is today.

Updated: March 19, 2020

Ryan Robinson
Ryan Robinson Ryan Robinson is a marketing and business consultant to the world’s top experts and growing startups. He teaches more than 350,000 monthly readers how to start and grow a profitable side business on his blog, ryrob.com.

Comments

  • Garrett Nafzinger

    How do I account for Solo 401k contributions in Gusto?

    Reply
    • Gusto Editors

      Hi Garrett — please reach out to our customer support team via the Help tab in your Gusto account so they can provide you support in this!

      Reply

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