If you’re self-employed or you’re a small business owner with no employees other than a spouse, a Solo 401(k) or individual 401(k) can help you save considerably more for retirement than you could with just an IRA. This type of account comes with astronomical contribution limits ($57,000 in 2020) when you consider both the employee and the employer contribution, and you don’t need a traditional employer or “boss” to open this account on your behalf.
The Solo 401(k) works just like it sounds like it would. Once you decide on an online brokerage firm, you take the initiative to open this account yourself. While there are a ton of online providers who offer excellent Solo 401(k) plans, we like TD Ameritrade for this type of account. Not only will you get an account without any added maintenance fees, but you’ll have the opportunity to access investing tools and choose among stocks, bonds, mutual funds, ETFs and more. In terms of Exchange Traded Funds, or ETFs, TD Ameritrade also offers more than 2,300 commission-free options to choose from.
TD Ameritrade also has brick-and-mortar branches in 48 states, so you can reach out for in-person assistance if you’re not entirely comfortable getting started with a Solo 401(k) online.
However, there are a lot of other online brokerage firms to consider for your Solo 401(k), and you’ll want to compare all the top options before you open this account. This guide can help you understand exactly how Solo 401(k)s work and how much you can save. We’ll also provide insights into the best online brokerage firms to consider for your retirement planning needs.
Quick Solo 401(k) Rules Guide
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How Much Can You Contribute to a Solo 401(k)?
In 2020, individuals with a Solo 401(k) can contribute a maximum amount on the employee end and the employer side of the equation.
As an employee, individuals can defer all their compensation up to the annual contribution limit of $19,500 for 2020. The only exception is, individuals ages 50 and older can contribute up to $26,000 as an employee of their company.
Note: These figures are up from 2019, when employee contributions were capped at $19,000 or $25,000 for individuals ages 50 and older.
The rest of the contribution Solo 401(k) participants can make is on the employer side. Here, you can contribute up to 25 percent of your compensation “as defined by the plan” up to an annual limit of $57,000 total (up from $56,000 in 2019).
How does this actually work in practice? Consider this succinct example:
Larry, age 51, earned $50,000 in W-2 wages from his small business in 2020. He deferred $19,500 in regular elective deferrals plus $6,500 in catch-up contributions to the 401(k) plan. Larry’s business contributed 25 percent of his compensation to the plan for the year, or $12,500. Total contributions to the plan for 2020 were $38,500.
Note that this type of plan allows you to contribute considerably more to a tax-advantaged retirement account than you could with a traditional 401(k) plan, which is limited to just $19,500 for 2020. The individual 401(k) lets you max that part out and contribute another 25 percent of your compensation on the employer side. The end result is the ability to save a ton for retirement and to reduce your taxable income in the process.
For reference, here’s how employee and employer contributions limits have changed for Solo 401(k) plans over the years for retirement savers under the age of 50.
|Contribution Year||Employee |
|Total Annual Contribution Limit
(Employee + Employer)
Where to Get Help Opening an Account
You can open a Solo 401(k) with any brokerage firm that supports this type of account, which is basically all of them. However, some online brokerage accounts do offer more perks and benefits than others.
We compared some of the top providers to help you narrow down your list of potential options. There are lots of excellent brokerage firms out there with various pros and cons, but this list includes some of our favorites:
$49.99 mutual fund
$0 set up
$0 mutual fund
$0 set up
0.25%-0.40% account balance annually
How Does a Solo 401(k) Work?
As a reminder, a 401(k) plan is nothing more than an individual retirement plan for self-employed people or small businesses without any employees. Also, remember that a Solo 401(k) is nothing more than a vessel you’ll use to save for retirement. You still have to choose the investments you’ll use within your account to build wealth.
The biggest benefit of this account is the fact that individuals who use it can contribute considerably more than they can with a traditional 401(k) plan, which in turn helps these individuals save more for retirement and reduce their taxable income.
There is another detail you should understand on the employer side. How do you determine 25% of your compensation? According to the IRS, your compensation is earned income, defined as “net earnings from self-employment after deducting one-half of your self-employment tax and contributions for yourself.”
As we shared already, Solo 401(k) participants can open their account with any brokerage firm they want, although online providers have become extremely popular due to the fact you can get started at home and on your own time, and often with access to an array of helpful investing tools and resources. Online brokerage firms also tend to come with low costs overall, which is another reason investors seek them out.
Solo 401(k) Rules You Need to Know
As you move closer to opening a Solo 401(k), there are some more details and rules you should know and understand. Here are some of the main Solo 401(k) rules that can help you figure out if this is the right plan for you.
To qualify for a Solo 401(k) plan, you need to be self-employed or own your own small business. You cannot have any full-time employees except for a spouse. You can have a part-time employee and still have this plan provided your part-time worker puts in less than 1,000 hours per year, or a little less than 20 hours per week.
When Do You Have to Take Distributions?
Where you were required to take Required Minimum Distributions (RMDs) at age 70 ½ until 2019, the recent passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act bumped that figure up to age 72.
In short, this means you’re required to begin taking distributions once you reach that age. This is unlike the Roth IRA, which doesn’t require distributions at any age.
Note that you can take distributions without a penalty any time after you reach the age 59 ½.
When Does a Solo 401(k) Have to Be Established?
To make a contribution to a Solo 401(k) for 2020, you are required to establish your individual 401(k) before the end of the year, or by December 31, 2020. It’s possible to make contributions to a Solo 401(k) after the new year (and before your tax filing deadline, which is normally April 15th) provided your business is not incorporated.
The $250,000 Rule
You should also be aware of one more rule. Once your Solo 401(k) plan grows to over $250,000 in assets, you’re required to file an annual Form 5500 EZ. You’re also required to file this form if you close your account.
Opening a Solo 401(k) comes with a ton of important benefits, the most important of which is your ability to save more money for retirement than you would otherwise. Since contributions to a Solo 401(k) are tax-advantaged, you can also invest more to reduce your taxable income now, although you will pay income taxes on Solo (k) distributions once you begin taking them in retirement.
If you’re self-employed, you should absolutely consider opening a Solo 401(k), but you can also consider the SEP IRA, which works differently but comes with the same annual limit of $57,000 for 2020.
And either way, make sure you compare all the top online brokerage firms to see which ones offer the internal investments you want with plenty of investing tools and resources. Also, make sure to compare fees so you know how much you’ll pay for account administration and any trades you make throughout the year.