The solo 401(k) is one of the most powerful retirement savings tools available to self-employed business owners—and it's dramatically underutilized. If you're self-employed with no employees (other than a spouse), this retirement plan deserves serious consideration. It offers contribution limits that rival corporate executive packages, and the tax benefits are substantial.
Let's start with the basics. A solo 401(k) is simply a 401(k) plan that covers only one person—the business owner. Because there's no need to include employees, the plan can be structured with features unavailable in traditional 401(k)s, including the ability to make profit-sharing contributions that escape payroll taxes entirely.
The contribution limits for 2024 are generous. As an employee, you can contribute up to $23,000 in salary deferrals (the same as a regular 401(k)). But as an employer, you can also make profit-sharing contributions of up to 25% of your net self-employment income. Combined, this can total over $50,000 per year in tax-deductible contributions—and if you're 50 or older, you get an additional $7,500 catch-up contribution, bringing the potential total to over $60,000.
Let's work through an example. Say you're a consultant with $200,000 in net self-employment income. As an employee, you defer $23,000. Your profit-sharing contribution is calculated as 25% of your net income minus the self-employment tax deduction. Roughly, you could add another $40,000-$45,000 in employer contributions. That's a potential $63,000 to $68,000 in total contributions—all tax-deductible.
The tax benefits are two-fold. First, your contributions reduce your taxable income, lowering your income tax bill. Second, and often overlooked, contributions as an employer (profit-sharing) reduce your self-employment tax. The IRS allows you to deduct half of your self-employment tax from your gross income when calculating your adjusted gross income (AGI). But profit-sharing contributions go further—they reduce the net self-employment income that the tax is calculated on.
