A Solo 401k Lets Self-Employed People Save Far More Than a Regular IRA

Trying to make the most of solo 401k lets self? You are in the right place. Below we break it down in plain English, with practical tips you can actually use.

Key Takeaways

• Most self-employed people never open one.
• They default to an IRA because it’s the account everyone knows, hit its low annual ceiling, and assume they’re done saving for retirement.
• The tax code allows far more room.

Most self-employed people never open one. They default to an IRA because it’s the account everyone knows, hit its low annual ceiling, and assume they’re done saving for retirement. The tax code allows far more room. An IRA just isn’t where it lives.

The solo 401k works by letting you wear both hats. As the employee, you defer up to the same annual IRS limit W-2 workers get. As the employer, your business adds a profit-sharing contribution on top: up to 25% of compensation if you’re incorporated, or about 20% of net self-employment earnings if you file a Schedule C. On $100,000 of net earnings, that employer side alone adds roughly $20,000 of contribution room.

Traditional pre-tax contributions also lower your adjusted gross income, so a strong year of profits turns into a smaller tax bill instead of a bigger one.

Eligibility is the main test. You need self-employment income and no employees, though a spouse who works in the business can join the plan. Most major brokerages offer solo 401ks, and opening one takes about as long as a standard brokerage account. Once it’s live, decide each year how much to put in on each side as profits allow. If you’re 50 or older, catch-up contributions raise the employee limit further. Numerous providers also offer a Roth option if you’d rather pay tax now and withdraw tax-free in retirement.

A solo 401k doesn’t replace your IRA either. You can fund both in the same year. If your business income has outgrown what an IRA can absorb, the solo 401k is where your next retirement dollar belongs.

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Final Thoughts

Before you check out, double-check solo 401k lets self against current offers and any coupons you can stack. Small habits like this add up to real savings over a year.

Originally published at moneycrashers.com.