Being a self-employed small business owner has a lot of perks, but a company-sponsored 401(k) plan isn’t one of them. Chances are you’ve looked into retirement savings plan options like a Solo 401(k). This investment plan can help you meet many of your retirement goals.

One of the greatest advantages of a solo retirement plan is the ability to self-direct your funds to invest in real estate, notes, or gold. It’s also a way for investors to avoid paying capital gains on the profits made. Before we talk about that, let’s first go through the basics of a solo 401(k). 

What is a Solo 401(k)?

A solo 401(k) is a retirement account made specifically for business owners who do not have employees. Compared to other types of retirement accounts, the solo plan provides several additional benefits. The most notable benefits include higher contribution limits and the option to self-direct the funds for investments. 

Next, I’ll explain two solo 401(k) options for business owners to consider. 

The Traditional Solo 401(k) 

Just like a traditional 401(k), an individual retirement account allows you to invest money pre-tax. The benefit is that it provides a nice tax break while you’re working. At retirement age, you can begin withdrawing money, but it will be taxed based on your income at that time. 

The biggest disadvantage to a traditional 401(k) is that your income tax rate may be higher when you reach retirement age than when you first invested. This means you’d essentially be eliminating any tax advantage you may have enjoyed during previous years.  

If you think you will be in a lower tax bracket when you retire compared to during your working years, then a traditional solo 401(k) could be a good option. 

The Roth Solo 401(k)

With Roth 401(k)s, contributions are taxed before hitting your retirement account. These after-tax dollars are taxed at your ordinary income tax rate. Because these funds have already been taxed, you can withdraw your money completely tax-free upon reaching retirement age. That includes your contributions plus any returns the account may have earned over the years.

Both the Roth and traditional plans have their own pros and cons. Once you decide which is the best plan for you, you’ll need to set up a trust to hold the funds. 

Solo 401(k) Eligibility Requirements

To qualify for a solo 401(k), an individual must be self-employed and have no full-time employees. However, business owners with part-time employees, such as freelancers and independent contractors, would still qualify for a solo 401(k). 

The second requirement to be eligible for a solo plan is that you must verify your earned income. Meeting both of these requirements will qualify business owners for an individual 401(k).  

Solo 401(k) Rules

Every type of retirement plan has a set of rules outlined by the IRS. The rules indicate how much you can contribute each year and when you are allowed to access your 401(k) funds. If these rules aren’t followed, the benefits of a solo 401(k) go out the window.

Solo 401(k) Contribution Limits

For 2024, the annual contribution limit on a solo 401(k) is $69,000. If you are 50 years or older, there’s an extra $7,500 catch-up contribution. 

The solo retirement plan is unique because it allows you to invest in two ways: as the business owner or employer and as the employee. 

As an employee, you may contribute up to $23,000 or 100% of your income (whichever is less). 

As the employer, you are allowed to make a “profit-sharing” contribution. This contribution can be up to 25% of your (the employer’s) net income. (Net profit minus self-employment tax and contributions). Remember that there is a limit on how much you can contribute based on your compensation/income. 

Here’s an example to help illustrate contribution limits for an individual 401(k): Imagine you are a 55-year-old self-employed business owner who made $100,000 in 2024. As the employee, you contribute the maximum yearly amount, $23,000, plus the catch-up contribution of $7,500 to your solo 401(k). 

As the employer, you contribute an additional 25% of your income ($100,000 x .25), which equals $25,000. 

The maximum allowable contribution to your solo retirement account for 2024 is $69,000. 

These limits apply to contributions made to multiple retirement accounts (if applicable). In other words, the overall contribution limit ($69,000) will be the same regardless of how many accounts you’re putting money into. 

Solo 401(k) Distributions

Distributions from your solo 401(k) can’t be made (at least without a hefty penalty) until the age of 59 ½ or another significant event occurs. 

In order to withdraw money from the account, one of the following events must occur: 

• The employer/employee reaches retirement age (usually 59 ½), as outlined by the retirement plan. 
• The employer/employee becomes disabled and unable to work. 
• The employer/employee dies (the beneficiary becomes eligible to access funds).
• The employer/employee part ways from the business.
• The account is closed and no replacement account is created.

In addition to these, there are certain “hardship distributions” that allow early access to the funds without paying a penalty. However, you must meet a number of criteria in order to qualify for a hardship distribution. 

Because the rules for each solo plan can vary, it’s important to check out your plan’s specific criteria for hardship distributions. While most plans allow early withdrawals for funerals and medical expenses, others will not allow early distributions for tuition expenses or to buy a primary residence. 

Generally speaking, solo 401(k) plans may include the following hardship distribution guidelines: 

• Medical expenses for you, your spouse or your dependents. 
• Funeral expenses for a parent, spouse, child or dependent.
• Mortgage payments to prevent the foreclosure of your primary residence.
• Up to $10,000 for the purchase of a primary residence (this does not include ongoing mortgage payments). 
• Expenses to repair your primary residence per the IRS’s casualty deduction. 

In short, unless you meet one of your plans’ hardship distribution requirements, you won’t be able to access the funds in your solo account early. If you do, expect to end up paying a lot of money in early withdrawal fees (around 10%). 

Solo 401(k) Withdrawal Deadline

Qualified 401(k) plans require you to begin making withdrawals no later than the age of 72. The withdrawals must be at least your required minimum distribution amount (see your plan for details). 

Advantages of Solo 401(k)s

We’ve discussed many benefits a solo 401(k) offers, especially compared to other retirement accounts. They are flexible and allow self-employed individuals to save for retirement without relying on a company-sponsored plan. Here are some additional big advantages of using a 401(k) plan as an individual.   

1. Tax Benefits

It’s well known that retirement accounts were meant to provide tax advantages. Both the solo Traditional and Roth 401(k)s offer tax breaks, just at different times. With a traditional, you may deduct any contributions when filing your taxes. In contrast, any contributions made to a Roth IRA will be taxed every year. Evaluate your own financial situation, retirement goals and timeline to help you determine which solo plan to pursue. 

2. Maximize Contributions 

Compared to other retirement plans, solo 401(k)s have the highest contribution limits. That’s because you can contribute in two ways, as the employer and the employee. This unique feature of the individual 401(k) is a huge advantage for those who are self-employed. 

3. A Spouse Can Contribute

If your spouse works for and earns income from your business as an employee, they can make elective deferrals to the individual retirement account. Depending on how much money your spouse earns, they can contribute up to the allowable limit ($23,000) plus a catch-up contribution (if applicable). You, the employer, can also add another 25% of compensation as a profit-sharing contribution. The solo 401(k) makes it possible to double your retirement contribution. 

4. Loan Option

When you are setting up a solo plan, you have the option to allow a loan option. With a loan plan, you can pull funds out of the account and receive a check in the mail. Because it’s a loan, you are expected to pay back the loan, plus interest, continuously. This option should only be used for emergencies as it will likely derail your retirement goals. 

5. Tax-Free Investing

People use the money in their self-directed retirement accounts to invest in alternative assets all the time. The solo plan can be self-directed to buy assets like gold, notes and real estate. The benefit is pretty obvious–tax-free investing. 

How To Invest in Real Estate with a Solo 401(k)

Unlike an employer-sponsored plan, a solo 401(k) is a self-directed retirement account and can be used to invest in real estate directly. Buying real estate with a self-directed IRA is a tax strategy commonly used by investors. 

The main benefit of using a solo 401(k) for real estate is that any income or gains from the investment are tax-exempt. For example, if you bought a property for $150,000 and later sold it for $400,000, the $250,000 in profits are tax-free.

Investing in real estate with a solo 401(k) is a great way to avoid paying capital gains taxes and can help you grow your retirement nest egg a lot faster.   

For a more detailed breakdown, check out our step-by-step guide for how to use an IRA to invest in real estate. 

Alternatives to the Solo 401(k)

The SEP-IRA was created for small business owners and is a similar but more complicated version of an individual 401(k). The SEP doesn’t offer as many advantages as the solo, and you cannot take loans from the account. 

If you work for a company that does not offer a retirement plan, a self-directed IRA is an excellent option to consider. 

Final Thoughts

A solo 401(k) can be a great retirement-saving vehicle for self-employed business owners. There are so many advantages (not just tax) these individual retirement accounts have to offer. If you don’t have a retirement plan in place yet, opening a solo 401(k) is a good place to start. Planning for retirement is essential in building real wealth and creating financial independence.