Using a Solo 401(k) to Fast Forward Your Retirement Savings

The following is a post by MPFJ staff writer, Kevin Mercadante, who is a professional personal finance blogger, and the owner of his own personal finance blog, He has backgrounds in both accounting and the mortgage industry.

The topic of solo 401(k) plans is usually one of those subjects reserved for small independent business people who are looking to establish a viable retirement plan for their business. It’s not a discussion that comes up often by many other people.

It needs to.

The solo 401(k), called more formally the one participant 401(k), has obvious benefits for anyone who is self-employed, but also great potential for someone who isn’t. More on that last point toward the end.

The plan is available for anyone who is self-employed – even if it is through an S corporation – as long as the business has no other employees. It is a simple plan to manage, with flexible investment options, and generous contribution limits.

But there’s more.

The solo 401(k) hidden advantage

When we think of 401(k) plans, we mostly interpret them through the lens of large employer plans. That means that you are able to contribute a percentage of your income – usually somewhere between 10% and 15% – and the funds accumulate on a tax-deferred basis until retirement. Some employers also offer a partial company match on the employees contribution.

Solo 401(k) plans are similar in the basics, but there’s one advantage they hold over employer-sponsored plans that make them worth investigating for anyone. Under IRS regulations, 100% of the first $17,500 ($23,000 if you‘re 50 or older) can be contributed to the plan.

Got that? 100% – there are no percentage of income limits up to that point.

That means that if you have a small business that earns $50,000 per year, you can contribute the first $17,500 of your income into the plan. If you had an employer sponsored plan that limited you to 10% of your income, your contribution on the same amount of compensation will be just $5,000. That’s a huge difference, and an advantage to the solo 401(k) that most people don’t even know about.

If you are self-employed, this contribution limit is far more generous than it would be for either a traditional or Roth IRA, where your maximum contribution is $5,500, or $6,500 if you’re 50 or older.

But once again, there’s more.

An outsized tax benefit

$17,500 is not only a big chunk of money going into your retirement plan, but it’s also a lot of money to deduct from your income for tax purposes. And that’s only the beginning.

With a solo 401(k), you are both the employee and the employer in your business. That means that you can also have an employer match to your basic employee contribution.

As employer, you can contribute up to 25% of total income to the plan. Let’s say that you earn $50,000 in your business. As the employer, you can contribute $12,500 to the plan (25% of $50,000) for your “employee” – who is also you.

When you add the $12,500 employer contribution to your $17,500 employee contribution, this gives you the ability to contribute up to $30,000 per year. Once again, that’s a lot of money to put into your retirement plan, as well as a huge tax write-off.

Think about it – your business earns $50,000, but 60% of that ($30,000) will not be subject to either federal or state income taxes.

Also think about the impact on your retirement savings of being able to contribute $30,000 per year to your plan. Even if you haven’t saved a single dollar for your retirement up to this point, $30,000 per year will provide a huge advantage in helping you to make up for lost time.

In fact, you can contribute up to $51,000 to the plan each year, limited to $17,500 for the basic employee contribution, plus 25% of total income as the employer contribution.


Setting up a side business – with it’s own solo 401(k)

So far we’ve discussed the potential to fast-forward your retirement savings with a solo 401(k) on a business that represents your primary occupation. But you can also establish a solo 401(k) for a side business.

This is why consideration of a solo 401(k) could be important even if you don’t have a business.

Let’s say that you are 45 years old you have about $50,000 sitting in your employer 401(k) plan. You earn $50,000 per year, and your employer plan limits you to contributions of no more than 10% of your income, or $5,000 per year. Not to be coldhearted, but you’ll never be able to fully retire under those circumstances.

But let’s say that you have the potential to start a side business – or maybe you already have one up and running. Let’s say that you are freelance blog writer, earning an additional $30,000 per year from your side business. If you establish a solo 401(k) plan attached to your writing business, you’ll be able to contribute $17,500 to the plan as an employee, plus an employer contribution of $7,500 (25% of $30,000).

That’s $25,000 in retirement savings, over and above your employer-sponsored plan.

At that rate, a comfortable retirement will be just a matter of time. Not only will this be a much more generous retirement plan contribution then you could get under an IRA, but it will also be fully tax deductible. IRA contributions have a limited tax deductibility if you’re already covered by a plan by your employer.

Starting a side business and attaching a solo 401(k) to it could be a way to either ramp up your retirement savings, or to do a fast catch-up if you haven saved much so far.

How about you all? If you are self-employed, have you checked out the benefits of a solo 401(k) plan? If you’re not self-employed, have you considered the possibility of starting your own side business, and using it to fast-forward retirement savings with a solo 401(k)?

Share your experiences by commenting below! 

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