If you’re self-employed and have no employees other than yourself and your spouse, you’re eligible to set up a one-participant 401(K), which is sometimes called a Solo 401(K), Solo-K, Uni-K, or One-Participant K. This is subject to the same rules as a regular 401(K) but can have some advantages for self-employed people.
You can contribute to the Solo 401(K) through salary deferrals, and also make elective matching contributions from the business. Like a 401(K), the maximum salary deferral in 2019 is $19,000, which goes up by $6,000 if you’re over 50. When combining your salary deferrals and the company match, the total maximum is $56,000, or $62,000 if you’re over 50. These limits may increase each year based on inflation.
Calculating the amount of the company match is more complicated than other types of retirement plans. The maximum is 25% of your net earnings, but net earnings takes into account half of your self-employment tax, and the company match you make for yourself, which is deducted as an expense. As a result, you have to do a manual calculation to figure out how much the company can contribute. You can find details of it in IRS Publication 560, or in a more succinct way on this page on the IRS site. Because of the complexity, I recommend getting input from a plan administrator, tax advisor, or retirement specialist.
A significant advantage to having a 401(K) with no employees is that you make matching contributions from the company without having to also match other employees. If you had employees, you would have to make matching contributions for all participants, so if you match yourself at a high percentage, you would have to also match everyone else at a high rate. With no employees, it’s easier to afford large contributions for yourself.
Because you have no employees, you don’t need to worry about contributions being discriminatory between highly and non-highly compensated employees, so you’re exempt from the discrimination testing you’d have with a typical 401(K). You’re also exempt from filing the annual Form 5500 if the plan assets are below $250,000.
These advantages go away if you hire employees. If they meet the eligibility requirements of the 401(K) plan, they have to be able to participate. You’ll be subject to discrimination testing, file the Form 5500, and make matching contributions for everyone.
Like a regular 401(K), you can set up a Solo 401(K) to allow for your salary deferrals to be made as Roth contributions. The company matches won’t be Roth, unless you roll them over to a Roth account and pay taxes on it. Non-Roth salary deferrals reduce your taxable income in the year you contribute, the growth is tax-deferred, and you pay taxes on the distributions you take in retirement. For Roth contributions, you pay tax on the amount you contribute in the year of the deferral, it still grows tax-free, but you pay no tax on distributions in retirement. If you’re making contributions for an extended period of time before retiring, most of what’s in your 401(K) will be growth, rather than what you contributed, so you end up saving a significant amount of taxes by making Roth contributions.
Other types of retirement plans to consider: