How to Open a 401(k) for Yourself Without an Employer
It is recommended to save as early and consistently as possible for your retirement. Selecting the optimal retirement plan depends on individual circumstances, including income, tax situation and financial goals.
If you are self-employed or a business owner, you have several retirement plan options to consider, including an Individual (or Solo) 401(k) plan. This flexible plan can allow you to contribute both as an employee and employer, which can increase your potential retirement savings.
What Is a Solo 401(k)?
A Solo 401(k), or a one-participant 401(k) plan, is designed for self-employed individuals or those owning businesses with no employees - other than their spouse. It offers the same benefits as a standard 401(k), but with a significant difference: Higher contribution limits. As both the employer and employee, one can contribute more to a Solo 401(k). Solo 401(k) plans allow different types of investments, including mutual funds, ETFs, stocks, bonds and real estate.
Eligibility Requirements to Open a Solo 401(k) To qualify for a Solo 401(k), one must be self-employed or own a small business with no employees other than a spouse. But you don’t need to be a full-time freelancer or business owner to qualify. You can own a Solo 401(k) even with part-time self-employment income, provided other eligibility requirements are met. If you juggle multiple jobs, your employee 401(k) limit gets applied to all the contributions you make across your plans - and not each individual plan. Note that the IRS will make you pay taxes and penalties on any distributions you make before age 59 ½ (with some exceptions).
Below are the maximum contribution limits for 2023 and 2024:
2023
· Up to $66,000 if under age 50:
o Employee deferral = $22,500
o Employer deferral = $43,500
· $73,500 if age 50 or older (adds additional $7,500 employee catch-up contribution)
2024
· Up to $69,000 if under age 50
o Employee deferral = $23,000
o Employer deferral = $46,000
· $76,500 if age 50 or older (adds additional $7,500 employee catch-up contribution)
How to Setup a Solo 401(k)
Opening a Solo 401(k) plan involves several steps to ensure one meets IRS regulations:
1. Check your eligibility: Confirm that you qualify to open a Solo 401(k) plan. You should be a self-employed individual or a small business owner with no full-time employees - other than yourself and your spouse.
2. Obtain an EIN: Obtain an Employer Identification Number (EIN) from the IRS if you do not have one. An EIN is required to open a Solo 401(k) plan, and is used to identify your plan and report contributions and distributions.
3. Choose a provider: Research and select a financial institution or provider that offers Solo 401(k) plans. This can be a bank, brokerage firm, custodian, or a specialized retirement plan provider. Fidelity; Charles Schwab; E*Trade; and Vanguard all offer solo 401(k) plans.
4. Select the plan type: Decide if you want a traditional Solo 401(k) or a Roth Solo 401(k). With a traditional plan, you will make pre-tax contributions, which could reduce your taxable income for the year. Roth 401(k) plan contributions are made with after-tax dollars which can provide tax-free withdrawals for your retirement.
5. Review and sign your plan agreement: Carefully read the plan agreement from your provider. This document outlines the terms and features of your Solo 401(k) plan. Sign the agreement.
6. Open your Account BEFORE year-end: A solo 401(k) must be set up before December 31 for the year in which you want to make contributions. For tax year 2023 contributions, you must set up your plan on or before December 31, 2023. Note this is different than an IRA or a SEP which you can set up after year-end.
7. File Form 5500-EZ: There is no annual reporting for your Solo 401(k) if the plan is worth less than $250,000. However, you must file Form 5500-EZ if the Fair Market Value of your Solo 401(k) assets exceeds $250,000 (as of December 31 of the preceding year) by July 31 of the following year. IRS penalties apply for failure to file the required form.
Alternatives to a Solo 401(k)
A Solo 401(k) is not the only option for self-employed individuals. Other retirement savings alternatives include traditional and Roth IRAs, SEP IRAs and SIMPLE IRAs. But when compared with IRAs, a Solo 401(k) allows higher contribution limits. And unlike SEP IRAs, a Solo 401(k) permits Roth contributions, which can offer you tax-free withdrawals in retirement.
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Best regards,
Janet Rhodes Friedman, CFP®, CDFA®, MBA
Janet@PlanWithFPS.com
617-630-4978
Financial Planning Solutions, LLC (FPS) is a Registered Investment Advisor. Financial Planning Solutions, LLC (FPS) provides this blog for informational and educational purposes only. Nothing in this blog should be considered investment, tax, or legal advice. FPS only renders personalized advice to each client. Information herein includes opinions and source information that is believed to be reliable. However, such information may not be independently verified by FPS. Please see important disclosures link at the bottom of this page.