I'm self-employed. Can I use a 401(k) plan?

I'm self-employed. Can I use a 401(k) plan?

Christopher Johns
February 11, 2024

Is it possible to have a 401K being self employed? The short answer - yes!

As a self-employed individual, planning for retirement can present unique challenges. Without the traditional employer-sponsored retirement plans, such as a 401(k), it’s crucial to understand the options available to secure your financial future. In this blog post, we’ll delve into the benefits of a single-member 401(k) for self-employed individuals, shed light on its feasibility for single-member LLCs and sole proprietors, and emphasize the importance of saving for retirement.

What is a 401K anyway?

A 401(k) is a tax-advantaged retirement savings plan. The are offered by employers to help employees save for retirement. It allows employees to contribute a portion of their pre-tax income into an investment account, where it grows tax-free until withdrawal during retirement. This provides an excellent opportunity for individuals to build their retirement nest egg while benefiting from potential investment growth.

I work for myself. Can I have a 401k?

It is now easier than ever for business owners, entrepreneurs, and the self-employed to open a 401K. Gone are the hassles of complicated paperwork and expensive startup cost. Many firms these days will offer the option for you to open a 401k just as easily as opening up any other type of brokerage account or IRA.

If you have employees, it is still possible to start a 401k plan, but there are more requirements. This will be covered in a later post. We will focus on a singe-member or “solo” 401k for now.

How much can I put in a Solo 401K?

There are pros and cons to all the different types of self-employed retirement accounts, and many of them share some qualities… like higher contribution limits. Specifically, in a Solo 401K:

“The self-employed can make contributions as both the employee and the employer. According to the IRS, you can contribute the following:

  • Elective deferrals up to 100% of compensation (“earned income” in the case of a self-employed individual) up to the annual contribution limit:
  • $22,500 in 2023 ($20,500 in 2022; $19,500 in 2020 and 2021), or $30,000 in 2023 ($27,000 in 2022; $26,000 in 2020 and 2021) if age 50 or over; plus
  • Employer nonelective contributions up to:
  • 25% of compensation as defined by the plan, or
  • for self-employed individuals, see discussion below

If you’ve exceeded the limit for elective deferrals in your 401(k) plan, find out how to correct this mistake.

Total contributions to a participant’s account, not counting catch-up contributions for those age 50 and over, cannot exceed $66,000 for 2023 ($61,000 for 2022; $58,000 for 2021; $57,000 for 2020).

Example: Ben, age 51, earned $50,000 in W-2 wages from his S Corporation in 2020. He deferred $19,500 in regular elective deferrals plus $6,500 in catch-up contributions to the 401(k) plan. His business contributed 25% of his compensation to the plan, $12,500. Total contributions to the plan for 2020 were $38,500. This is the maximum that can be contributed to the plan for Ben for 2019.

A business owner who is also employed by a second company and participating in its 401(k) plan should bear in mind that his limits on elective deferrals are by person, not by plan. He must consider the limit for all elective deferrals he makes during a year.

Contribution limits for self-employed individuals

You must make a special computation to figure the maximum amount of elective deferrals and nonelective contributions you can make for yourself. When figuring the contribution, compensation is your “earned income,” which is defined as net earnings from self-employment after deducting both:

  • one-half of your self-employment tax, and
  • contributions for yourself.

Use the rate table or worksheets in Chapter 5 of IRS Publication 560, Retirement Plans for Small Business, for figuring your allowable contribution rate and tax deduction for your 401(k) plan contributions. See also Calculating Your Own Retirement Plan Contribution.”

If you have more than $250,000 in assets at the end of the year, you are generally required to file an annual report on Form 5500-EZ. You would want to consult your tax professional for specifics on this.

You can also open a Roth 401K, which gives you all the advantages of a 401k and a Roth IRA. The contribution limits are the same and can even be split between a regular 401k and Roth 401k.

There are other options available to the self-employed and business owners, which future articles will address.

Whatever you decide, save something in something!

As a self-employed individual, planning for retirement is crucial for your long-term financial well-being. The single-member “solo” 401(k) offers self-employed individuals the opportunity to save more for retirement, enjoy tax benefits, and have control over their investments.

By prioritizing retirement savings, you can secure your financial future and enjoy a comfortable retirement, even as a self-employed professional. Remember, it’s never too early to start saving for retirement! If you would love to discuss your options more, please feel free to give us a call or schedule an appointment.