How does a Solo 401K work?

A Solo 401(k), also known as a Self-Employed 401(k), is a retirement plan designed for those who are self-employed or business owners with no full-time employees other than the owner and their spouse. It allows both employee and employer contributions, which can lead to higher potential retirement savings compared to other retirement plans. Here are the key features:

1. Employee and Employer Contributions: As the owner, you can contribute both as an employee and an employer. For example, in 2021, you could contribute up to $19,500 as an employee and an additional 25% of your compensation as an employer contribution, up to a combined total maximum of $58,000 or $64,500 if you are age 50 or older. 1

2. Tax Benefits: Contributions to a Solo 401(k) can be made on a pre-tax basis, lowering your taxable income for the year. Alternatively, Roth contributions can also be made, which allows for tax-free growth and withdrawals, provided certain conditions are met. 2

3. Flexibility with Contributions: You have the flexibility to adjust contributions annually based on business income, which is particularly beneficial for businesses with fluctuating income. 3

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     Corporate 401K Insights

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     Solo 401K Insights

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     Solo 401K Benefits

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     Retirement Account Strategies

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4. Ease of Setup: Solo 401(k)s can be set up relatively easily with various financial institutions that offer low or even no fees for the plan. This setup provides control over investments, which can help manage and potentially lower costs. 4

5. High Contribution Limits: The ability to make both employee and employer contributions significantly increases the potential total annual contributions compared to other retirement plans geared towards the self-employed, such as SEP IRAs and SIMPLE IRAs. 5

6. Secure Act Modifications: Recent legislative changes under the SECURE Act allow the establishment of a Solo 401(k) after the year's end but still make employer contributions for that year. This provides additional flexibility and planning options. 6

Overall, a Solo 401(k) offers substantial tax advantages and higher contribution limits, making it an appealing option for maximizing retirement savings for self-employed individuals or small business owners with no employees other than the spouse.