Have you heard of the solo 401(k), aka the solo-k? If not, you may have failed to consider the best retirement plan option for you. We understand that exploring every option out there is exhausting, and even if you try to do it, you might not fully comprehend your choices and end up with a plan that doesn’t fit your situation well.
We’re here to help explain what a solo-k is, how you can benefit and what the contribution limits are for this retirement plan.
What Is a Solo-k?
The benefits of owning your own business are many — you make all the decisions, you work whatever hours you want to work, you choose who you want to work with and when. It sounds like a dream — until you consider the drawbacks, one of which is that you get boxed out of joining a 401(k) plan and reaping the benefits of employer contributions. But all is not lost.
While you may be familiar with a traditional 401(k), the solo-k is a plan that is specifically for sole proprietors, independent contractors, freelancers — any small business that has no employees.
You are likely aware that you are free to open an individual retirement account — an IRA or a Roth IRA, depending on whether you want to contribute post- or pre-tax dollars. But in many ways, this type of retirement vehicle falls short of providing the benefits of a solo-k. How?
The amount you’re allowed to contribute to an IRA in 2023 is puny: $6,500, or $7,500 if you’re 50 or above. With a solo-k, you can contribute a whopping $66,000 to your solo-k, plus another $7,500 if you’re 50 or older. This is because the rules that govern a solo-k allow you to make contributions as both the employee and the employer. The employee limit is $22,500 for 2023, plus $7,500 if you’re 50 or over. As the employer, you can contribute 25% more of your income (similar to a match), up to the limit. (The rules for calculating what your compensation is are pretty specific, so you may want to have your accountant go over the numbers to ensure you are following the law correctly.)
You can choose from between a traditional solo-k or a Roth solo-k, depending on whether you want to pay taxes on the money you contribute now or when you withdraw it in retirement. There are different reasons to make this decision, but one common reason investors choose a Roth retirement plan is because they expect to be in a larger tax bracket when they retire, so paying the taxes earlier means they save money. If you’re older, this may not be a consideration.
The Spouse Exception
We mentioned earlier that the IRS rules for a solo-k say you must have no employees in order to be eligible to open this type of account, but there is an exception for a spouse who works for you. If your spouse helps you with your business and you pay them compensation for their work, they are also eligible for a solo-k. They may open their own solo-k, or contribute to one that you hold jointly.
This is a great benefit, because by adding your spouse, the two of you may double your contributions to $132,000, or $147,000 if you are both over 50. You can only do this, however, if the spouse earns enough money. They would be allowed to contribute 100% of their salary, and you could contribute the extra 25% as their employer, but if they only earn, say, $50,000, you could not simply chip in to make up the rest.
This type of scenario works best with a couple who earns a lot of money and wants to quickly feather their retirement nest. After all, the reason the extra catch-up amount is allowed for investors over 50 is because they have far fewer years to allow their money to grow before retirement, which is not the case with younger workers.
It’s important, however, to remember when you and your spouse are making these contributions that the limits apply to the individual, which means if either of you contributes to a 401(k) plan at another job, or to an IRA, this money is counted toward the $66,000 total.
A Penny Saved
While it’s true that not everyone has the means to divert in excess of $100K from their bank account to their retirement account, if you find yourself in the position to be able to do this, it’s important to know that the option is available and what the rules are surrounding it. You may decide to sell your home or another large asset, you may inherit money or even win the lottery(!), allowing you to save 100% of what you earn for the year.
A 401(k) account is typically expected to grow 5%-8% per year. When you consider the interest is compounded, the more you put in — and the earlier you put it in — the faster and bigger your nest egg grows.
Ready to open your solo-k? Do it today, with 401GO.