What Is a Solo 401(k)?

A solo 401(k) is a 401(k) retirement plan designed specifically for small business owners who have no employees. If your business has even one employee, you do not qualify for a solo 401(k) plan. But you can cover yourself and your spouse with a solo 401(k).

The rules governing solo 401(k) plans are just like those governing traditional 401(k), Roth 401(k), and other 401(k) plans. There are annual contribution limits, early withdrawal penalties and the ability to make catch-up contributions.

Solo 401(k) plans also allow business owners with no employees to take advantage of 401(k) tax breaks while saving for retirement.

A solo 401(k) can be set up as a traditional 401(k) or a Roth 401(k) to take advantage of each type’s unique tax advantages.

In addition, as your own employer, you’re allowed to contribute an employer-matching contribution into the plan. This money is tax-deductible up to the IRS’s employer contribution limits.

You can open a solo 401(k) plan through various financial institutions including online brokerage firms, investment firms or insurance companies that offer them.

Before you set up a solo 401(k), the Internal Revenue Service requires that you have a written plan declaring which type of plan — a traditional 401(k) or a Roth 401(k) — you intend to use. This written plan may be an IRS-approved form provided by the institution where you set up your solo 401(k) plan.

You then need to create a trust — an agreement with the institution to hold title to the assets in the 401(k) plan to protect your investment and oversee distributions and withdrawals.

There are no age or income restrictions for setting up a solo 401(k) plan, but you must be a business owner with no employees.

The IRS limits how much you are allowed to contribute each year to a solo 401(k) plan, but the tax code allows the business owner to be employer and employee under 401(k) rules.

That means you can make an employee contribution and an employer contribution to the plan. You can also make both types of contributions on behalf of your spouse.

You can also cover your spouse with your solo 401(k) plan, effectively doubling the potential contributions to the plan each year.

In addition to making employee contributions for your spouse, you can also make an employer matching contribution up to IRS limits, according to the Pension Research Council at the University of Pennsylvania.

You can also make catch-up contributions — additional contributions as you near retirement age — once you turn 50.

Total contributions, not counting catch up contributions, can’t exceed $66,000 per person — you and your spouse, if covered — for 2023.

If you are a business owner who has a 401(k) through a second job, you are still limited to $57,000 spread across both plans. The limit is per person, not per plan.

There is typically a penalty if you withdraw money from a solo 401(k) prior to six months after your 59th birthday. The penalty is 10 percent of your withdrawal. You will also have to pay income taxes on the money you take out.

There are a few exceptions that will allow you to withdraw money without having to pay the penalty, but you will still have to pay taxes on the money you withdraw.

The CARES Act of 2020 also eliminated the 10 percent penalty on COVID-19 related withdrawals if they were made for hardships directly related to the pandemic.

One-third of the money you take out will be taxed as income each year, spread out over three years, but you will not have to pay the additional penalty. The act also allows you to increase your contributions beyond the limits to pay back the money you withdraw if you’re able to do so.