I Chose the Solo (Individual) 401K for My Small Business

Philip Taylor, CPAByPhilip Taylor, CPA

After a couple of years away from the corporate world, one thing I did miss was my 401K. The company I used to work for dumped the matching contribution at some point, but I still loved that plan. I could defer taxes on several thousand dollars in income each year. That’s a huge benefit in my book.

This benefit pushed me to save the maximum each year and amass a decent retirement account for a guy in his thirties. I also had a Roth IRA, which is a great compliment to anyone with a 401K, who meets the income requirements.

But when I left for the self-employed world and lost the ability to contribute to my 401K, I found that the Roth IRA alone wasn’t enough. After a year or so of struggling with the business to get it to a point to where I actually had enough to start considering retirement contributions again, I decided to open up a Solo (or Individual) 401K.

Solo 401K Rules

I’m eligible to open this type of plan because I have no full-time employees. You can open one too if you have a side income and want to contribute some of those funds to a retirement plan outside of your current 401K or Roth IRA. Just keep in mind that Solo 401K contribution limits are spread across multiple 401K plans.

Solo 401K Contribution Limits

This thing is awesome. Not only can I contribute $20,500 a year, but since I’m the employer, I can contribute up to 25% of the compensation I pay myself, up to $61,000. The total annual contribution from both employee and employer is capped at $61,000, for 2022. That’s a huge deferral! Far greater than I could have ever achieved being employed.

If I choose to bring Mrs. PT on as an employee one day, then we can contribute up to the limit for her as well. Considering future “catch-up” contributions, this account could allow us to defer over $100,000 in income one day. One can dream, right?

Opening a Solo 401K

Additionally, a Solo 401K is very easy, and inexpensive to set up since I’m allowed to be the trustee of the account. I looked around and chose Vanguard as the place to open my account. As you know I like their philosophy, funds, and low expenses. The $20 annual fee on the plan is waived because I’m at the Voyager level with Vanguard.

Solo 401K Contribution Deadline

I opened the account in December of 2011, and because of the genius of my accountant, was able to make the employee deferral portion before the end of the year, the deadline. Now I have until I file my business taxes to make the employer contribution.

My goals for this account going forward are the same as they were with my old 401K, contribute the maximum each year. I’m going to speak to my accountant about doing more routine paychecks in the future so that I can contribute on a more routine basis vs all at the end of the year.

Do you use a Solo 401K? What do you like about the plan?

Philip Taylor, CPA

Philip Taylor is a CPA, writer, podcaster, entrepreneur, and founder of FinCon. He also owns TravelCon and runs The Creator CPA, a CPA firm specializing in accounting services for content creators.

Philip has been quoted and featured in multiple media outlets, including The New York Times, The Washington Post, Forbes, Fox Business, and more.. Connect with him on Twitter or LinkedIn.

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6 Comments

  1. “since I’m the employer, I can contribute up to 25% of the compensation I pay myself,”
    NOT true unless you are incorporated. Please read up the rules for SEP-IRA/401k for the “self-employed/sole proprietor” as the math is not that simple for the employER side of the equation. You take into account half the self-employment tax paid and then use a rate table. It usually works out to roughly 20%. The 25% number you see bandied about is very misleading. Fidelity has a nice worksheet for Solo 401k that you can google and download the PDF. It’s titled “401k-CW-0902.pdf”.
     
    We had a SEP originally, so we use that for the employER side, and just use the 401k for the employEE side. (By having our SEP at Wells Fargo brokerage, we can buy all sort of stuff, including Vanguard funds, all for free with PMA option.) The employEE salary deferral is a flat rate of $17K, and is only available under the 401k, not the SEP. And yes, the limits are high!
     
    Also, with the Vanguard 401k, you can NOT do a loan from it. You can, however, have a Roth-401k option. And, while it looks like it’s free, you need to have $10K in EACH fund that you add to your account, or you get a $20 fee for each fund. Pick 5 funds that are each under the $10K limit by June, and you’ll pay $100 in fees.
     
    To manage the Vanguard 401k, you need to open two logins. The first log in is to the small business account, where you transfer money to your “employee”, and allocate it to a certain fund. But to see how that fund it doing and what your dividends are, you log in under a “personal” account. Here you can “exchange” money around from the cash account to a mutual fund, etc.

  2. Philip Taylor Philip Taylor says:

    If you use ADP as a payroll service provider, I’m assuming you can tell them where you want your money placed.

    Vanguard has excellent customer service. I’d start there.

  3. How do you make the employee contribution with a Vanguard Solo 401k? I use ADP for payroll and I am under the impression they won’t do the employee deduction for the vanguard 401k (they have their own 401k plan) from payroll. How else can I contribute and it still be a payroll tax deduction?

  4. So, why a Solo 401k and not a SEP-IRA?

    1. Philip Taylor Philip Taylor says:

      @SunWKim Good question. I meant to answer that one. For the longest time I thought the SEP IRA was what I wanted to do. Three aspects about the Solo 401K appeal to me over the SEP: it’s meant for the solo practitioner, it’s contribution limits are the highest, and you can borrow from it if needed.

    2. Philip Taylor Philip Taylor says:

      @SunWKim Additionally, the SEP IRA can be used in addition to a regular 401K if you are still employed and not compete with contribution limits. When I was still employed and had side income coming in the SEP IRA looked like the way to do the trifecta: 401K, SEP IRA, Roth IRA. Now that I’m fully self-employed the Solo 401K makes the most sense.

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