Solo 401k Definition: What It Is, Who Qualifies & Key Rules

What Is a Solo 401k?

A Solo 401k (also called Individual 401k or One-Participant 401k) is a retirement plan designed specifically for self-employed individuals and business owners with no employees except a spouse. It combines the benefits of being both employee and employer, allowing you to make contributions in both roles for maximum retirement savings.

Key Features

• Dual contribution structure (employee deferrals + employer profit-sharing)
• High contribution limits compared to other retirement plans
• Investment flexibility and control
• Optional loan provisions
• Roth and traditional tax treatment options

Who Qualifies?

Eligible:

• Sole proprietors, LLCs, partnerships, S-corps with earned income
• Business owners with no common-law employees (except spouse)
• Spouses who work in and receive compensation from the business

Not Eligible:

• Businesses with employees who work 500+ hours annually for three consecutive years
• Anyone age 21+ who meets the hours requirement must be included

2024 Contribution Limits

Employee Deferrals

• Under 50: $23,000 maximum
• Age 50+: $30,500 maximum (includes $7,500 catch-up)

Employer Contributions

• Up to 25% of compensation (after self-employment tax adjustments)
• Based on maximum compensation limit of $345,000

Total Combined Limits

• Under 50: $69,000 maximum
• Age 50+: $76,500 maximum

Tax Advantages

Traditional Solo 401k

• Contributions are tax-deductible
• Reduces current taxable income
• Taxes paid on withdrawals in retirement

Roth Solo 401k

• Contributions made with after-tax dollars
• Tax-free growth and qualified withdrawals
• No immediate tax deduction

Strategy Tip

Many participants split contributions between traditional and Roth to hedge tax rate changes.

Setup Process

1. Obtain EIN

Apply for Employer Identification Number through IRS website or by phone.

2. Choose Provider

Compare based on:

• Setup and annual fees
• Investment options
• Online platform features
• Customer service quality

3. Adopt Plan Documents

Complete by December 31 to make current-year deferrals:

• Adoption agreement
• Trust agreement
• Summary Plan Description

4. Fund the Plan

• Employee deferrals: By December 31
• Employer contributions: By tax filing deadline (April 15 or extension date)

Administrative Requirements

Annual Filing

Form 5500-EZ required when:

• Plan assets exceed $250,000 at year-end
• Final plan year (termination)
• Due July 31 (extension available to mid-October)

Recordkeeping

Maintain documentation for:

• Contribution records
• Investment selections
• Plan amendments
• Participant communications
• Fiduciary decisions

Compliance Responsibilities

• Act as plan fiduciary with duty of loyalty and prudence
• Monitor service providers and fees
• Follow plan document terms
• Update plan for legislative changes

Distribution Rules

Early Withdrawals (Before Age 59½)

• Subject to 10% penalty plus income tax
• Exceptions for disability, medical expenses, IRS levy

Normal Distributions (Age 59½+)

• Penalty-free withdrawals
• Traditional contributions taxed as ordinary income
• Roth contributions and earnings tax-free if account open 5+ years

Required Minimum Distributions

• Must begin by April 1 after turning age 73
• Applies to both traditional and Roth Solo 401k accounts
• 25% penalty for missed RMDs (reduced to 10% if corrected quickly)

Solo 401k vs Other Plans

Common Pitfalls to Avoid

Setup Challenges

• Missing December 31 adoption deadline
• Failing to obtain EIN before plan establishment
• Inadequate provider research leading to high fees

Compliance Issues

• Late or missing Form 5500-EZ filings ($250/day penalty)
• Improper employee classification
• Failure to update plan for law changes

Growth Limitations

• Plan becomes invalid when hiring eligible employees
• Must convert to regular 401k or terminate plan
• Transition can be costly and complex

Advantages vs Disadvantages

Pros

• Highest contribution limits for self-employed
• Tax flexibility with traditional and Roth options
• Investment control and loan provisions
• No nondiscrimination testing required
• Spouse can participate

Cons

• More complex than IRA alternatives
• Higher setup and maintenance costs
• Annual filing requirements for larger balances
• Becomes invalid when adding employees
• Significant fiduciary responsibilities

Key Deadlines Summary

• Plan Adoption: December 31 for current-year deferrals
• Employee Deferrals: December 31 of plan year
• Employer Contributions: Tax filing deadline (April 15 or extension)
• Form 5500-EZ: July 31 (extension to mid-October available)
• RMDs: April 1 after turning 73, then December 31 annually

Next Steps

1. Verify Eligibility: Confirm no disqualifying employees
2. Calculate Potential Contributions: Estimate tax savings and retirement impact
3. Research Providers: Compare fees, features, and investment options
4. Establish Timeline: Plan setup to meet December 31 deadline
5. Consider Professional Help: Consult tax advisor or plan administrator for complex situations

A Solo 401k can be an incredibly powerful retirement savings tool for eligible business owners, offering unmatched contribution limits and tax advantages. However, success requires careful planning, ongoing compliance, and understanding of the administrative responsibilities involved.