When you're self-employed, you lose access to the bundle of benefits that 9-5 workers have.
You're responsible for withholding taxes, getting health insurance, and most importantly - investing for your future.
The Solo 401(k) was designed to give independent workers access to the same tax-advantaged retirement account that regular, full-time employees have.
The nice thing: it's even better than a regular 401(k)
You can contribute over $60,000 each year, you can invest in more than stocks & bonds, and you can reduce your overall tax bill.
Here's a quick breakdown of one of my favorite investment accounts:
For starters, the name "Solo 401(k)" means that to qualify, you can't have any full-time employees (which is why it's perfect for freelancers & creatives).
However, if you have a spouse that works for the business, they're not considered an employee for qualification purposes, so you'd both be able to have an account. You can also work with contractors and some part-time hires without disqualifying yourself for a Solo 401(k).
Unlike other retirement accounts, there are no income restrictions that stop you from putting money in a Solo 401(k). The biggest eligibility requirement is having a business with no W2 employees. If you fit that description, you're in luck.
You'll most likely need your EIN (Employer Identification Number) to apply and if you don't have yours yet, here's a walkthrough I made on how to get one.
The first place where the Solo 401(k) shows its strengths is with its contribution limits.
In 2022, the annual contributions limits—because you're both the employer and the employee—are $61,000. In 2023, the contribution limit will go up to $66,000. Your business may not have enough revenue to max out the account, but it gives you room for growth. This is a big advantage for those pursuing early retirement and those with high revenue businesses.
Another advantage is the ability to invest in either Traditional or Roth accounts. Most 401(k)'s are Traditional, which means when you put money into the account, you can write it off and lower your taxes in the current year. Then at retirement, you'd owe taxes when the money is withdrawn.
For a Roth account, you can't write off your contributions - BUT you can withdraw all of the money in the account without paying taxes after age 59 1/2.
There are several different places where you can open a Solo 401(k), but not all of them offer both Traditional and Roth account options.
I prefer to have the tax flexibility of both, so you may want to keep an eye out when selecting an investment company. For example, Vanguard offers both options (shown below):
After choosing an investment company, then you'd take the standard investing steps of opening your Solo 401(k) account, depositing funds, and picking your investments.
If you're not sure how to pick investments, check out last week's post about how to create a simple portfolio.
We've touched on a few of the benefits, but here's a quick list:
While investing should be a relatively simple process, there are still some things you need to be aware of:
While you could technically open one at any time if you qualify, it's important to make sure your business is financially healthy before making investments.
If you're just getting started - maybe a year or two into independent work - and you're covering your bills but there's not much money left over to invest, don't feel like you're behind.
It's okay to spend several years investing in your business first because in a way, your business can be viewed as part of a retirement plan. If you create a valuable asset, you might be able to sell it in the future. That could be hard for a one-person creative business, but investing in yourself & your skillset can help you generate more income in the future, which would allow you to invest more later (making up for the lack of contributions when you were getting started).
A general rule of thumb is to invest 15-20% of your income. So if you're able to easily cover your monthly expenses and you have a 3-6 month cash reserve, it might make sense to open an account and start funneling extra money into a Solo 401(k). This generally starts to happen once the business is making $50,000+.
A few of the most popular places include:
If you want to take a deep dive into Solo 401(k)'s, this guy wrote an entire book on the subject.