Is Solo 401(k) plan "best kept secret" of tax code?

Solo 401(k) Retirement Plan

Solo 401(k) Retirement Plan

By Symone Graham - Staff Writer

March 08, 2024

Self-employment comes with several perks, but one disadvantage is not having access to an employer-sponsored retirement plan such as a 401(k).

Self-employment comes with several perks, but one disadvantage is not having access to an employer-sponsored retirement plan such as a 401(k).

That's where a Solo 401(k) plan can be a bright spot, including for Charlotte small-business owners. That plan is eligible for business owners without employees. They can also use the plan to cover their spouse, but can't contribute to what the IRS calls a one-participant 401(k) if they have full-time workers.

Andrew Reagan, founder of Charlotte product management consultancy company Dado Digital, has been using a Solo 401(k) plan since his freelance business was established in 2017. He told CBJ that he sees it as the biggest tax advantage from running his own company.

"Since you're the owner of the company, you can be very gracious to your employees, especially when your employee is only you," Reagan said.

Because an individual business owner is acting as both an employee and employer when using a Solo 401(k), the total contribution limit is up to $69,000 for 2024. There's also a catch-up contribution of an additional $7,500 for business owners aged 50 or older.

How does that break down? As the employee, business owners can contribute up to $23,000 in 2024, or 100% of compensation, whichever is less. As the employer, they can contribute up to 25% of their compensation to the account. There's also a compensation limit of $345,000 in 2024. Contributions must be made by the tax filing deadline.

"So, I pay myself a salary out of my business, and then I get a dividend as an owner for the other portion of my business," Reagan said.

In 2019, Reagan said he was able to contribute about $50,000, pre-tax to his Solo 401(k) plan.

"At the end of the year, I just kind of look at it as my profit from the business," Reagan said. "And then if I want to get in a lower tax bracket, or I just had a really good year, and I just want to save as much as I can, then I'm able to do that."

Judson Gee, managing partner at Charlotte's JHG Financial Advisors, said another perk of the Solo 401(k) is that the startup cost is low, or sometimes, there isn't one at all. It's generally between $0 and $125 to open an account.

He said unlike a traditional 401(k) plan, the Solo 401(k) doesn't have compliance-testing requirements. That's to ensure the plan doesn't favor highly compensated business owners that could contribute more than lower-paid individuals.

The Solo 401(k) plan also features a loan provision. Business owners can borrow up to $50,000 from the account for any purpose, and the interest is paid back to them since they're "acting as the bank," Gee said.

"So, it's a great thing for people to have, especially small-business owners that might all of a sudden have that need and don't want to go out to a traditional bank," he said.

Greg Brown, fund administrator at Charlotte Angel Fund and managing partner at Cardinal Finance, said he contributed to a Solo 401(k) during the early stages of his consulting company that's designed for entrepreneurs.

"I would view it as a very appropriate thing for almost anyone who goes out on their own with a consulting business or anything elsewhere," he said.

Gee added, "The solo 401(k), I think, is the best kept secret of the tax code."