How Solo 401K Works

In today's fast-paced world, financial security and retirement planning are of paramount importance. While many people are familiar with traditional 401(k) plans, the concept of a Solo 401(k) may still remain shrouded in mystery for some. This article is designed to shed light on how Solo 401(k) works, providing an in-depth understanding of this retirement savings option.


10/26/20235 min read

How Solo 401K Works
How Solo 401K Works

What Is a Solo 401(k)?

A Solo 401(k) is a retirement savings plan designed for self-employed individuals or small business owners with no full-time employees, other than a spouse. It combines the features of a traditional 401(k) and a profit-sharing plan, allowing for higher contribution limits and more control over your investments.


Consider Sarah, a self-employed web developer. She doesn't have any full-time employees in her business except her husband, who helps manage administrative tasks. Sarah is eligible for a Solo 401(k) and can make the most of this plan's features to secure her retirement.

Who Is Eligible for a Solo 401(k)?

To be eligible for a Solo 401(k), you must be self-employed or a small business owner with no full-time employees, except for a spouse. This category includes sole proprietors, freelancers, independent contractors, and small businesses. It's an excellent option for those looking to maximize their retirement savings.

Case Study:

John, a freelance writer, meets the eligibility criteria for a Solo 401(k) because he operates his writing business independently. He can enjoy the benefits of this plan to save for retirement.

Contributions to a Solo 401(k)

Contributions to a Solo 401(k) come in two forms: elective deferrals and employer contributions. Elective deferrals allow you to contribute a portion of your income, similar to a traditional 401(k). Meanwhile, employer contributions are based on your business's profitability.

Case Study:

Michael, a small business owner, earned $80,000 in net self-employment income in a given year. He chose to make a $19,500 elective deferral (the 2023 limit for individuals under 50) to his Solo 401(k) and also contributed 25% of his net self-employment income as an employer contribution, which was an additional $20,000. This allowed him to save a substantial amount for retirement while reducing his taxable income.

Tax Benefits of Solo 401(k)

One of the most attractive features of a Solo 401(k) is the potential for significant tax benefits. Contributions are tax-deductible, reducing your taxable income. Additionally, the earnings in your Solo 401(k) account grow tax-deferred, providing substantial long-term advantages.


Let's say you contribute $25,000 to your Solo 401(k) in a year. This $25,000 is deductible from your taxable income, potentially moving you into a lower tax bracket and reducing your tax liability.

Investing with a Solo 401(k)

A Solo 401(k) offers a wide range of investment options, from stocks and bonds to real estate and alternative investments. This flexibility empowers you to tailor your investment portfolio to align with your financial goals.

Case Study:

Mary, a self-employed real estate agent, used her Solo 401(k) to invest in rental properties. Over the years, her real estate investments generated a steady stream of rental income, which grew tax-deferred within her Solo 401(k). This allowed her to diversify her retirement portfolio beyond traditional investments.

Advantages of Solo 401(k)

The Solo 401(k) presents several advantages, including high contribution limits, tax advantages, and investment flexibility. It allows you to build a substantial retirement nest egg while maintaining control over your investments.


Richard, a small business owner, appreciated the ability to make larger contributions to his Solo 401(k) during profitable years. This flexibility allowed him to save a significant amount for retirement when his business had a prosperous period.

Limitations of Solo 401(k)

While Solo 401(k) plans offer numerous benefits, they do come with some limitations. It's crucial to be aware of these limitations, such as the requirement to have self-employment income and potential restrictions on contributions in highly profitable years.

Case Study:

Amy, a self-employed graphic designer, faced a year of business losses. During this period, she couldn't contribute as much to her Solo 401(k) due to the requirement that contributions are based on self-employment income.

Setting Up a Solo 401(k)

Establishing a Solo 401(k) is relatively straightforward. You need to adopt a written plan document, choose a custodian or trustee, and open a separate bank account for the plan's assets. This process ensures that you're in compliance with IRS regulations.

Case Study:

David, a freelance photographer, consulted with a financial institution specializing in Solo 401(k) plans. They helped him set up his plan, create a plan document, and guided him through the process, ensuring that he met all IRS requirements.

Contribution Deadlines

Contributions to a Solo 401(k) must be made by the tax filing deadline, including extensions. This means that you have until the tax filing deadline of the following year to make contributions for the current tax year.


If the tax filing deadline is April 15, you have until that date (or later with extensions) to make contributions for the previous tax year. This flexibility allows you to plan and maximize your contributions.

Rollovers and Transfers

If you have funds in an existing retirement account, you can roll them over into your Solo 401(k) without penalties or taxes. This flexibility allows you to consolidate your retirement savings.

Case Study:

Sarah had an old 401(k) from a previous job with a significant balance. She decided to roll over these funds into her Solo 401(k). This not only simplified her retirement accounts but also allowed her to take advantage of the Solo 401(k)'s higher contribution limits.

Distributions and Withdrawals

When it's time to access your Solo 401(k) savings in retirement, you can choose between regular distributions or lump-sum withdrawals. Each option has its tax implications, so it's essential to plan your withdrawals carefully.


If you opt for regular distributions, you can receive a consistent income in retirement. On the other hand, if you decide on lump-sum withdrawals for specific financial needs, be mindful of the potential tax consequences.

Recordkeeping for a Solo 401(k)

Proper recordkeeping is vital when managing a Solo 401(k). You need to keep detailed records of contributions, investments, and distributions to ensure compliance with IRS rules.

Case Study:

Lisa, a self-employed consultant, maintained meticulous records of her Solo 401(k) transactions. This included documenting contributions, investment changes, and withdrawal details, which made tax reporting a smooth process and ensured she stayed organized throughout the year.

Solo 401(k) vs. SEP IRA

Comparing a Solo 401(k) to a SEP IRA can help you make an informed decision about the best retirement plan for your needs. Each has its advantages and limitations, so understanding the differences is crucial.


Tom, a self-employed IT contractor, carefully considered the options and chose a Solo 401(k) because it allowed him to make larger contributions in prosperous years while maintaining investment flexibility.

Common Misconceptions

There are several misconceptions about Solo 401(k) plans that can lead to confusion. Addressing and clarifying these myths will help you make more informed choices regarding your retirement planning.

Case Study:

Eva, a small business owner, initially believed that a Solo 401(k) was only for high-income earners. However, after consulting with a financial advisor, she learned that individuals with various income levels can benefit from this retirement plan.


In conclusion, a Solo 401(k) is a powerful retirement savings tool for self-employed individuals and small business owners. Its combination of high contribution limits, tax benefits, and investment flexibility makes it a compelling choice. By understanding how Solo 401(k) works and reviewing real-life examples and case studies, you can take control of your financial future and make well-informed decisions about your retirement planning.


  1. What is the maximum contribution limit for a Solo 401(k)?

    The maximum contribution limit for a Solo 401(k) can vary, but in 2023, it's $61,000 for individuals under 50 and $67,500 for those 50 and older.

  2. Can I have a Solo 401(k) if I have a full-time employee other than my spouse?

    No, Solo 401(k) plans are designed for self-employed individuals or small business owners with no full-time employees other than a spouse.

  3. Are Solo 401(k) contributions tax-deductible?

    Yes, contributions to a Solo 401(k) are tax-deductible, reducing your taxable income.

  4. What investment options are available in a Solo 401(k?

    Solo 401(k) plans offer a wide range of investment options, including stocks, bonds, real estate, and alternative investments.

  5. Can I roll over funds from an existing retirement account into a Solo 401(k?

    Yes, you can roll over funds from an existing retirement account into a Solo 401(k) without penalties or taxes.