The Solo 401(k): The Most Flexible Retirement Account for Creators

November 18, 2022

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:

How it Works

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 Then at retirement, you'd owe taxes when the money is withdrawn.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.

The Advantages of a Solo 401(k)

We've touched on a few of the benefits, but here's a quick list:

  • Reduce your taxable income (with Traditional Solo 401k contributions)
  • OR get tax-free withdrawals (with a Roth Solo 401k)
  • You can buy & sell investments without being taxed in the current year
  • Some offer access to alternative investments like private equity, real estate, and more
  • Can help reduce taxable income to qualify for certain tax credits
  • Can offer tax flexibility in early retirement

What to Watch Out For

While investing should be a relatively simple process, there are still some things you need to be aware of:

  • Once you have more than $250,000 invested, you're required to file Form 5500 at the end of each year. Your investment company will most likely provide you with the information needed to file the form.
  • If you're working with an accountant, you need to make sure they're aware of the account and know how much was contributed throughout the year.
  • If you withdraw funds from a Traditional Solo 401(k) prior to reaching age 59 1/2, you'll incur a 10% penalty and owe taxes on the amount withdrawn
  • With a Roth Solo 401(k), you can generally withdraw contributions tax-free (because you already paid tax on that money) and any earnings would be subject to taxes & a 10% penalty. This can be tricky to calculate, so here's an explainer from Investopedia:
  • Account fees & individual investment fees
  • While it can be a grey area, the IRS states that contributions must be "recurring" and "substantial". There aren't defined guidelines, but as long as you don't open an account, put $5 in, and not touch it for several years, you'll most likely be fine. I'd talk with your accountant or financial planner to be sure you're meeting requirements.

When Does It Make Sense to Open a Solo 401(k)?

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+.

Where to Open a Solo 401(k)

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.

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