Being self-employed comes with great perks: doing work you care about, setting your own hours, and building something from the ground up. But there’s one thing it usually doesn’t include—a retirement plan like a 401k from an employer. That’s where the solo 401k comes in. Also known as a one-participant 401k, it’s designed for self-employed individuals and gives you many of the same benefits as an employer-sponsored plan, but with more flexibility.

Here’s a breakdown of what a solo 401k is, who can use it, and its pros and cons.

Can I Open a 401k On My Own?

Yes, you can open a 401k on your own if you’re self-employed or own a small business. It’s called a solo 401k or individual 401k. Here’s what you need to know:

• Eligibility: According to IRS guidelines, you must be self-employed or run a business with no full-time employees. (Your spouse can also participate.)
• Choose a Provider: Many financial institutions offer solo 401ks. Compare their fees, investment options, and services before picking one.
• Traditional vs. Roth: Solo 401ks come in both versions.
  • Traditional: Pre-tax contributions; you pay taxes when you withdraw in retirement.
  • Roth: After-tax contributions; you withdraw tax-free in retirement.
• Contribution Limits: You can contribute both as the employee and the employer.
  • For 2023: Up to $66,000, or $73,500 if you’re 50+ (with catch-up contributions).
  • Limits change yearly—check the IRS website for updates.
• Set Up the Plan: After choosing a provider and plan type, fill out the necessary forms. Some providers let you apply online.
• Make Contributions: Once the account is open, start contributing. Stick to the yearly limits, and consider automating contributions.
• Tax Reporting: You may need to report your solo 401k to the IRS—especially if your plan exceeds a certain value. Contributions can also lower your taxable income.
• Withdrawals: You can’t withdraw money without penalties until you’re 59½—unless certain exceptions apply.
• Required Minimum Distributions (RMDs): Traditional solo 401ks require withdrawals starting at age 72. Roth solo 401ks do not.
• Closing or Rolling Over the Plan: If you hire employees, you may need to close the plan or roll it into a different retirement account.

Does An Individual 401k Need A TPA?

If your solo 401k has less than $250,000 in assets, you don’t need a third-party administrator (TPA). You’ll have minimal reporting duties. Once your plan grows above $250,000, the IRS requires Form 5500, and hiring a TPA might help manage the rules and paperwork. While not required for small plans, a TPA can be helpful as your plan gets larger.

Is a Solo 401k a Good Idea?

There are some pros and cons that come along with opening a solo 401k. Here are some advantages and disadvantages to consider before opening a 401k on your own.

Benefits of a Solo 401k

• Higher Contribution Limits: You can contribute as both the employee and the employer, allowing for much higher total contributions compared to SEP IRAs or traditional IRAs.
• Flexibility: Offers both traditional and Roth options for tax planning.
• Loan Option: Some plans let you borrow from your 401k without early withdrawal penalties.
• Tax Savings: Contributions can lower your taxable income in the year you make them.
• No Age Limit for Contributions: You can keep contributing as long as you have self-employment income.
• More Control: You choose your investments and how much to contribute.
• Creditor Protection: 401k accounts are usually well-protected from creditors under federal law.

What Are The Downsides Of A Solo 401k?

• No Employer Matching: Since you’re the employer, there’s no outside company adding extra contributions.
• More Complex: Compared to other plans, solo 401ks can be more complicated to set up and manage—especially if your account value is high.
• Possible Fees: Some providers charge for setup, maintenance, or extra features like Roth options or loans.
• Eligibility Limits: You can’t have full-time employees (other than a spouse). If you do, you’ll need a different plan.
• Over-Contribution Risk: Since you’re contributing in two roles, it’s easy to go over the limit if you’re not careful.
• Limited Access to Funds: Unless your plan offers loans, accessing money before age 59½ usually means paying penalties and taxes.

It’s a smart idea to speak with a financial planner to see if a solo 401k fits your needs. They can help you understand the rules, avoid costly mistakes, and make the most of your retirement savings.

Have questions? Contact Zynergy Retirement Planning to get personalized help with your self-employed retirement options.