Why All Solopreneurs Should Consider Opening a Solo 401k

Today, I have a very informative article from Paul Kim of Carry Money all about the benefits of having a solo 401k, how much you can contribute each year, and how a solo 401k works. Since many of my readers are self-employed, I thought this would be the perfect topic to cover today, as saving…

A solo 401k is one of the most powerful wealth-building tools for self-employed individuals. It comes with the highest contribution limits of any retirement plan, tax-free compounding, the ability to invest in any asset class, and more.

I’ve been self-employed for most of my professional life – 9 years to be exact. In my early 20s, I discovered the possibility of making money online, taught myself how to build blogs, learned SEO, and have been making a great living growing content businesses for nearly a decade.

Recently, I joined the team at Carry Money as a full-time employee, and many people have asked me why I would ditch working for myself to become an employee.

I have two answers for them:

First, the founder of Carry Money, Ankur Nagpal, built and grew his last company, Teachable, to a $250 million business in just a few years. Being able to work alongside him, along with the talented founding team he recruited, is an amazing opportunity. And after nearly a decade of solopreneurship, I crave working as part of a group to achieve a greater goal.

Second, what Carry Money is building is something I passionately wanted to exist for a very long time – a supercharged, intuitive solo 401k plan for self-employed people like me.

I had heard of a solo 401k before joining Carry Money, but like many people I’ve talked to, eventually dismissed the idea after realizing how complex (and expensive) it can be to set up and maintain a self-directed account. Major banks only offered a cookie-cutter version of the plan without any of the good features, and none of the other third-party providers looked promising enough to trust with my retirement savings.

At Carry Money, we launched our self-directed solo 401k plan with checkbook control. And we completely reimagined the sign up flow and user experience to make it as intuitive and accessible as possible.

If you’re a business owner or self-employed (ie. you run a blog, freelance, or are a creator), I’d love to share some reasons why you should look into getting a solo 401k.

Even if you don’t care about retirement savings right now, the tax benefits of having an account can potentially save you tens of thousands of dollars each year.

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What is a solo 401k?

What’s a solo 401k? I’ll talk more about this in just a bit but, in short, it’s a special kind of 401k plan designed specifically for business owners and self-employed people. It offers the highest contribution limits, a big Roth account, and the ability to invest in any asset class with tax-free compounding.

Unlike a normal 401k, you don’t need an employer to sponsor a plan in order to participate.

As a business owner or self-employed individual, you can set up an account and start making contributions on your own.

How do you qualify for a solo 401k?

To be eligible for a solo 401k, all you need are two things:

Any sort of business activity.
No full-time W-2 employees that work over 1,000 hours per year in your business (excluding your spouse).

There are no income limits (all income levels are eligible whether you make a few hundred per week or have a seven-figure business), and any type of business entity qualifies. However, you cannot have any full-time employees other than your spouse. You can still work with contractors and freelancers, but W-2 employees that work over 1,000 hours per year that are not your spouse will disqualify you from a solo 401k.

What’s so special about a solo 401k?

A solo 401k gives you more control and flexibility than any other retirement plan. Let’s do a quick run through of all the benefits and features.

A quick note before we dive in: Not all plan providers will offer these features with their plans. If you’re looking to sign up for a solo 401k, make sure you do your research and find a provider that offers the benefits that you’re looking for.

1. Highest contribution limits

A solo 401k has the highest contribution limits of any retirement plan out there. For 2022, you can contribute up to $61,000 or $67,500 if you’re at least 50 years of age. For 2023, you can contribute up to $66,000 or $73,500 if you’re at least 50 years of age.

For comparison, a normal 401k plan has a contribution limit of $20,500 for 2022 and $22,500 for 2023. And a traditional or Roth IRA has a contribution limit of just $6,000 for 2022 and $6,500 for 2023.

2. Invest in any asset class

When you invest through a normal 401k that you receive from your employer, your investment options are usually limited to around a dozen mutual funds that are pre-selected by your company.

With a traditional or Roth IRA, you get a wider range of investment options, but you’re still limited to just traditional assets like stocks, bonds, ETFs, and mutual funds.

With a solo 401k, you can invest in any asset class. In addition to traditional assets, you can also make alternative investments into assets like cryptocurrencies, NFTs, real estate, precious metals, and private equity.

3. Tax-free compounding

As with most other retirement plans, a solo 401k comes with tax-free compounding. When you sell assets and make a profit, you don’t pay any capital gains tax. Instead, 100% of the earnings go straight back into your account, where it can get reinvested.

This also applies if you decide to invest in something like an investment property, which is possible through a self-directed solo 401k plan that allows alternative investments. All rental income you receive from tenants would be tax-free, and if you decide to sell your property in the future, all profits would also go straight back into your solo 401k account, completely tax-free.

4. Roth option

When you sign up for a solo 401k, many premium plan providers will offer you two different accounts.

A traditional (pre-tax) solo 401k account.
A Roth (post-tax) solo 401k account.

These work similarly to a traditional and Roth IRA. If you’re unfamiliar with how these work, here’s a quick breakdown of the two types of accounts.

With a traditional retirement account, you make contributions with pre-tax dollars (income that you haven’t paid taxes on yet). The amount you contribute to your account gets deducted from your taxable income for the year. However, withdrawals in retirement will be taxed as regular income.

With a Roth retirement account, you make contributions with post-tax dollars (income that you’ve already paid taxes on). You don’t get any tax breaks for making contributions, but your withdrawals in retirement are completely tax-free.

Example: Let’s say that you earned $80,000 this year and decide to contribute $20,000 into your solo 401k. If you contribute that money into a traditional solo 401k, it gets deducted from your taxable income and you only have to pay taxes on $60,000 of income rather than $80,000. However, if you contribute $20,000 into a Roth solo 401k, your taxable income is still the full $80,000.

Now let’s pretend that the $20,000 contribution gets invested and, over the next few years, grows to a value of $200,000. If it was invested through a traditional solo 401k, you’ll have to pay income taxes when you decide to make a withdrawal of your funds in retirement. However, if it was invested through a Roth solo 401k, because you already paid taxes on your contribution, your withdrawals in retirement would be completely tax-free.

5. Mega backdoor Roth

If you love Roth accounts, the solo 401k has another feature that lets you contribute even more money into a Roth solo 401k than is typically allowed.

Normally with a solo 401k, you can contribute up to $22,500 into a Roth account for 2023. If you’re at least 50 years of age, you can contribute up to $30,000. With a mega backdoor Roth solo 401k, you have the ability to contribute up to the solo 401k contribution limit entirely into your Roth account. Instead of being able to contribute just $22,500, you can contribute up to $66,000 ($73,500 if age 50+) into your Roth solo 401k for 2023.

6. The largest possible tax deduction

Because of its high flexibility, you have full control over what type of contribution you want to make into your solo 401k plan each year.

You can allocate some of your funds to pre-tax and the rest to Roth, you can do a mega backdoor and put the entire amount into a Roth solo 401k, or you can even decide to not contribute to a Roth account at all for the year.

If you decide to contribute everything to a traditional solo 401k, it’s possible to get a tax deduction of up to $66,000 ($73,500 if age 50+) for 2023.

7. Rollovers

You can rollover assets from any other retirement account, except a Roth IRA, into a solo 401k plan. If you have assets in another retirement account, rolling it over to a solo 401k immediately gives you access to more investment options.

For instance, if you have $50,000 sitting in your traditional IRA, you can roll it over tax-free into a solo 401k and invest the money into alternative assets.

There are no limits on how much you can rollover into your solo 401k, and rollovers do not affect your annual contribution limits. For example, if you decide to rollover $50,000 into your solo 401k this year, you’ll still have the full contribution limit of $66,000 remaining.

Solo 401k Contributions explained

Contributions to a solo 401k work a little differently than other retirement plans. Since you’re the owner of your business, you get to make contributions as both the employer and the employee. Each side has slightly different rules and limits. Let’s go through them below.

Employee contributions: As an employee of your business, you can contribute up to 100% of your compensation up to $22,500 for 2023. If you’re at least 50 years of age, you also get an additional $7,500 in catch-up contributions, bringing your total contribution limit to $30,000.

Employer contributions: As the employer, you can contribute up to 25% of your compensation if your business is incorporated, and up to 20% of your compensation if your business is not incorporated.

The total employee and employer contributions must not exceed the annual solo 401k contribution limit, which is $66,000 for 2023 ($73,500 if age 50+). Employee contributions can be made as pre-tax or Roth (or both), but employer contributions can only be made as pre-tax.

How do withdrawals work with a solo 401k?

Withdrawals from a solo 401k work similarly to other retirement plans. You can start making withdrawals from your account once you reach the age of 59½.

Withdrawals made before turning the age of 59½ are subject to a 10% early distribution penalty plus income taxes on the amount withdrawn.

For example, if you make an early withdrawal of $10,000 before you turn 59½ years old, you’ll have to pay $1,000 in penalties plus income taxes on the $10,000 withdrawn amount.

Traditional vs Roth withdrawals

After the age of 59½, withdrawals do not get hit with the 10% penalty.

However, depending on the type of account you withdraw from, you may still have to pay income taxes.

Qualified distributions from a traditional solo 401k are taxed as regular income, and the amount in taxes depends on your tax bracket and tax rates at the time of withdrawal. Qualified distributions from a Roth solo 401k are tax-free.

Solo 401k vs other retirement plans

Let’s take a look at how a solo 401k compares with other popular retirement plans like the IRA, SEP IRA, and 401k.

Solo 401k vs SEP IRA

The closest comparison to a solo 401k is the SEP IRA. Both retirement accounts are designed for business owners and they have the same contribution limits. However, there are some major differences to be aware of if you’re trying to decide between the two.

Roth option: A solo 401k has a Roth option while a SEP IRA only comes with a pre-tax traditional option. All contributions to a SEP IRA must be made as pre-tax contributions.
Catch-up contributions: The solo 401k and SEP IRA have the same contribution limit of $66,000 for 2023. However, a solo 401k has catch-up contributions while a SEP IRA does not. If you’re at least 50 years of age, a solo 401k allows you to contribute up to $7,500 more in 2023, bringing your total contribution limit to $73,500.
Investment choices: A solo 401k lets you invest in both traditional and alternative assets, while you can only make traditional investments with a SEP IRA. Put another way, a SEP IRA only lets you invest in things like stocks, bonds, mutual funds, and ETFs, while a solo 401k also lets you invest in alternative assets like cryptocurrencies, NFTs, real estate, and private equity.
Employees: SEP IRA owners are allowed to have full-time employees, while with a solo 401k, you’re not allowed to have any full-time W-2 employees that work over 1,000 hours in your business (excluding your spouse). The caveat is that SEP IRA owners must make equal percentage contributions for every eligible employee in their business. For example, if you decide to contribute 15% of your compensation into your SEP IRA, you’re obligated to also contribute 15% of every eligible employee’s compensation into their SEP IRAs as well.

Solo 401k vs 401k

A 401k plan is an employer-sponsored retirement plan.

In order to participate in a 401k, you must work at a company that offers one to their employees.

On the other hand, a solo 401k is for individual business owners and can be opened without an employer. Here are some of the major differences between a solo 401k and 401k.

Investment options: A 401k typically only lets you invest in around a dozen mutual funds that are pre-selected from your employer. You can’t pick out individual stocks of companies you like, you can’t invest in your favorite ETFs, and you can’t invest in alternative assets. In comparison, a solo 401k lets you invest in any asset class, whether it’s traditional assets or alternative investments like crypto, real estate, and private equity.
Contribution limits: As an employee, you can only contribute up to $22,500 into a 401k plan, or up to $30,000 if you’re at least 50 years of age. However, with a solo 401k, since you can contribute as both the employee and the employer, your contribution limit is 3x higher at $66,000 for 2023, or $73,500 if you’re at least 50 years of age.
Rollovers: Most 401k plans do not allow you to rollover your 401k assets into another retirement account while you’re still employed at the company. With a solo 401k, you can rollover your funds into any other retirement account whenever you want.
Roth option: While some employers do offer a Roth option as part of their 401k plan, most plans only offer a traditional 401k account. With a 401k, whether you have a Roth option or not is entirely up to your employer. With a solo 401k, you get the freedom to choose a plan provider that offers the benefits you’re looking for, like the Roth account.

Solo 401k vs IRA

The main difference between a solo 401k and an IRA is that a solo 401k is only for business owners while any individual with earned income can contribute to an IRA. Here are the main differences between the two plans.

Contribution limits: The contribution limit of a solo 401k is 10x higher than the contribution limit of a traditional or Roth IRA. A solo 401k has a limit of $66,000 for 2023 ($73,500 if age 50+), while an IRA has a limit of just $6,500 for 2023 ($7,500 if age 50+).
Investment options: An IRA only lets you invest in traditional assets like individual stocks, bonds, mutual funds, and ETFs. A solo 401k lets you invest in both traditional assets and alternative assets. Technically, you can also invest in alternative assets through an IRA through a self-directed IRA. However, these accounts typically do not give you something called checkbook control (explained further down below), which is very important if you want to invest in alternative assets.
Income limits: IRAs have income limits that restrict contributions or tax deductions if your income is too high. For example, with a Roth IRA, you cannot contribute at all if your modified adjusted gross income (MAGI) is over $153,000 for 2023. With a traditional IRA, you can still make contributions if your income is too high, but you won’t get any tax deductions for your contributions if your MAGI is over $83,000 for 2023.

How does checkbook control work?

At Carry Money, we deliberately launched our solo 401k plan to come with something called checkbook control. Before we sign off, I wanted to share a little bit about it since many people I’ve spoken with have never heard of it before.

Checkbook control means exactly what it sounds like: You get control over your solo 401k account’s checkbook. Essentially, you have full control over your solo 401k’s bank and investment accounts and can write checks and wire funds directly when you want to make an investment.

Here’s how it works

When you sign up for a solo 401k plan, you get a separate bank and brokerage account for your solo 401k trust. As the trustee of your plan, you get checkbook control over those accounts and can write checks directly when you want to make an investment.

For example, if you want to buy crypto, you would open a new account with an exchange using your solo 401k plan trust as the owner, and fund your account using your solo 401k bank account. If you want to invest in a startup, you would simply write a check from your solo 401k plan trust bank account.

With other self-directed solo 401k plan providers, they’ll create the solo 401k plan docs for you, but you need to find a third party bank and brokerage and ask them to accept the docs and open your accounts for you.

With Carry Money, we have integrated brokerage accounts and they’re created as a default part of your account instantly when you sign up. You can fund your accounts through your dashboard, make investments into traditional assets through our investment platform, or wire funds and write checks directly.

Checkbook control gives you complete freedom to invest in whatever asset class you want, without having to go through a plan custodian to approve your purchase and wire the funds for you. It’s one of the most powerful features of a self-directed solo 401k plan.

Conclusion

A solo 401k is one of the most powerful wealth-building tools for business owners and self-employed individuals. It comes with the highest contribution limits of any retirement plan, a mega-sized Roth account, tax-free compounding, and the ability to invest in any asset class.

To qualify, all you need is any sort of business or self-employment activity, with no full-time W-2 employees that work over 1,000 hours per year in your business. All business entities are eligible, whether you operate as a sole proprietorship, LLC, partnership, s-corporation, or c-corporation.

Surprisingly though, while being one of the most flexible retirement plans out there, it’s lesser known than other plans like the 401k or IRA. The reason is, setting up a solo 401k has always been a complex process, and requires reading through and signing dozens of pages of documents and application forms.

At Carry Money, we completely redesigned the signup process from the ground up. What used to take hours or days now takes just a few clicks and can all be done through our website in under 10 minutes.

That was a long read! If you’re still here with me, awesome and thank you for reading to the end. If you’re interested in learning more about setting up a solo 401k, I’d be more than happy to answer any questions below and even help guide you through our application process if you decide to sign up.

Author bio: Paul Kim is a money nerd and finance blogger. Before joining the team at Carry Money to work on content and education, he built two different finance media brands from zero to over a million readers per year. In his spare time, he likes listening to money podcasts at 2x speed while hiking with his dog, Elliot.

Are you saving for retirement? What questions do you have about solo 401ks?