Investing in a solo 401(k) is a common retirement savings plan for self-employed individuals or small business owners. Let’s break down how it works, gets taxed and what potential deductions you can take. As with all retirement plans, how much you can save will depend on your specific circ*mstances. Therefore, getting personalized advice from a financial advisor could help you reach your goals.
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How a Solo 401(k) Works
The solo 401(k), also known as a one-participant 401(k), is a retirement savings plan designed specifically for self-employed individuals or small business owners with no full-time employees other than their spouse. This plan allows for substantial tax deductions on contributions, significantly reducing your taxable income. However, the effectiveness of these deductions can vary depending on personal circ*mstances.
A self-employed individual who can make a maximum contribution of $66,000 in 2023 ($69,000 in 2024) to their solo 401(k). You can contribute $22,500 in 2023 ($23,000 in 2024) as elective deferrals and the employer, or your business, can contribute up to 25% of your compensation, but it must be defined by your plan.
To qualify for a solo 401(k), you must be a business owner with no full-time employees, other than a spouse, who generates self-employment income. If you fit this description, then you could benefit from higher contribution limits with a solo 401(k) than traditional IRAs, make tax-free growth of investments and get tax deductions on contributions.
How a Solo 401(k) Is Taxed
Contributions to a solo 401(k) are usually made with pre-tax dollars, which reduces your current taxable income. However, the tax treatment is different when you establish a Roth account. For this type of solo 401(k), you would pay taxes upfront on your contributions. And consequently not be able to deduct them from your federal taxes.
Distributions are generally taxed as ordinary income, depending on the tax bracket that you fall into. Additionally, you should note that early withdrawals before age 59 1/2 may incur a 10% penalty on top of regular income taxes.
Potential Tax Deductions With a Solo 401(k)
The main tax perk involves reducing your taxable income through contributions made to the plan. All of your contributions are made in pre-tax dollars so you don’t earn as much money, for taxes, in the moment.
In 2023, the maximum deduction for solo 401(k) contributions is $66,000 ($69,000 in 2024). This can go up to $73,500 for those aged 50 or older ($76,500 in 2024). The amount that you can claim for tax deductions, however, depends on several factors such as your income, age and the type of contributions (employee or employer) you make.
To claim these beneficial deductions, ensure that contributions are made by your tax return’s due date and you gather all the necessary documentation, such as your W-2, 1099, or Schedule C. Claim deductions by entering your total contributions on line 28 of Form 1040 Schedule C for self-employed individuals, or on the deductions worksheet for corporations. For assets over $250,000, file IRS Form 5500-EZ.
If you’re self-employed and operate as a sole proprietor, partnership, or an LLC taxed as a sole proprietorship, you might be able to deduct contributions for yourself from your personal income.
Bottom Line
A solo 401(k) can be beneficial for self-employed individuals, offering potentially higher contribution limits, and allowing savers to benefit from tax advantages. Though, make sure you understand tax requirements for eligibility and deductions.
Tips for Tax Planning
- If you want to make sure you’ll be as protected as you can be come tax time, you may want to enlist the help of an experienced financial advisor. They can help you make a financial plan that fully takes your taxes into consideration. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you canhave a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re curious whether you’re on the right path for your tax plan for the current year, consider using SmartAsset’s free income tax calculator.
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FAQs
Potential Tax Deductions With a Solo 401(k)
How much of a solo 401k is tax deductible? ›
If you make all your contributions with pre-tax dollars into a traditional solo 401k, you can deduct up to the maximum contribution limit of up to $69,000 ($76,500 if age 50+) for 2024. However, getting maximum tax deductions also means that you're not contributing anything to the Roth account.
How much of my 401k contribution is tax deductible? ›
You won't need to claim your 401(k) contributions as tax deductible when filing your taxes. While contributions to qualified retirement plans, such as traditional 401(k)s, are not technically tax-deductible, they do provide tax benefits.
What is the downside of a solo 401k? ›
Drawbacks to the solo 401(k)
Like other 401(k) plans, the solo 401(k) will hit you with taxes and penalties if you withdraw the money before retirement age, currently set at 59½.
How do I avoid 20% tax on my 401k withdrawal? ›
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
Can I contribute 100% of my salary to my Solo 401k? ›
If you're at least 50 years old, you can add a catch-up contribution of $7,500, for a total employee contribution of $30,500. You can choose to contribute up to 100% of your compensation, provided you don't exceed these limits. Feed your brain. Fund your future.
Where do I deduct my Solo 401k contribution as a sole proprietor? ›
It acts and is treated like any other 401(k) plan. Essentially, this plan has the sole owner and sole employee making contributions to the same one plan. This means you will report the total amount (as sole owner and sole employee) contributed as an adjustment on Schedule 1, line 16.
What should my 401k deduction be? ›
That said, most financial advisors agree that 10% to 20% of your salary is a good amount to contribute toward your retirement fund—and at minimum, you should contribute enough to secure a company match.
Is a 401k tax deductible for self-employed? ›
A Self-Employed 401(k) may substantially reduce your current income taxes because generally, you can deduct the entire amount of your plan contributions from your taxable income each year. If your business is unincorporated, you can deduct contributions for yourself from your personal income.
Can you deduct 401k contributions with standard deduction? ›
Unless you're a business owner, you won't claim your 401(k) contributions as tax deductible when you fill out your Form 1040. Instead, the money is taken out of your paycheck before federal taxes on your income are figured. This is how you save on taxes today.
Contributions to a solo 401(k) are usually made with pre-tax dollars, which reduces your current taxable income. However, the tax treatment is different when you establish a Roth account. For this type of solo 401(k), you would pay taxes upfront on your contributions.
What is the income limit for Solo 401k? ›
The limits are the same as for the Solo 401(k): $69,000 for 2024 (up from $66,000 in 2023); however, your contribution cannot exceed 25% of your gross adjusted income. No catch-up contribution is allowed for those age 50 or older. No Roth option is available.
Do you get double taxed on a 401k withdrawal? ›
Do you pay taxes twice on 401(k) withdrawals? We see this question on occasion and understand why it may seem this way. But, no, you don't pay income tax twice on 401(k) withdrawals. With the 20% withholding on your distribution, you're essentially paying part of your taxes upfront.
How do I take out my 401k tax-free? ›
The easiest way to borrow from your 401(k) without owing any taxes is to roll over the funds into a new retirement account. You may do this when, for instance, you leave a job and are moving funds from your former employer's 401(k) plan into one sponsored by your new employer.
How much tax should I withhold from my 401(k) withdrawal? ›
Once you begin receiving distributions from your 401(k), you'll owe income taxes on the funds. Some 401(k) plans will automatically withhold 20% to pay for taxes, however, you'll want to check with your plan provider to see how your 401(k) works.
Does a Solo 401k file a tax return? ›
Form 5500-EZ is the filing requirement for Solo 401k plans with $250,000 or more in plan assets. It is simply an informational return that is filed with the IRS. Solo 401k plans with assets totaling less than $250,000 have no filing requirement at all.
Do contributions to Solo 401k reduce AGI? ›
A 401(k) retirement plan will reduce both your AGI and MAGI, as contributions are taken out of your salary before taxes are deducted. This in effect reduces your salary in relation to taxes. Because your salary is now "lower," you end up paying less taxes. This is the tax benefit of a 401(k) retirement plan.
How much of 1099 income can I put in Solo 401k? ›
401(k) plan
Contribute up to an additional 25% of your net earnings from self-employment for total contributions of $69,000 for 2024 ($66,000 for 2023, $61,000 for 2022; $58,000 for 2021; $57,000 for 2020 and $56,000 for 2019), including salary deferrals.
What is the after tax contribution for Solo 401k? ›
Normally, you are limited to Roth contributions of $23,500 per year (or $31,000 if you are age 50 or older). However, Solo 401k voluntary after tax contributions allow you to put up to $69,000 per year (or $76,500 per year if you are age 50 or older) into your retirement plan!
