By Nolan Lewis
Key Points:
- -The Solo 401(k) is a tax-efficient retirement plan designed for self-employed individuals or business owners with no employees (except a spouse).
- -Roth option: A Roth Solo 401(k) lets you contribute post-tax dollars now and withdraw tax-free in retirement, without income restrictions.
- -Higher Contribution Limits: In 2024, the cap for Solo 401(k) is $76,500 if you’re 50 or older, far exceeding the Roth IRA limit of $8,000.
- -Employer and employee can contribute: The Solo 401(k) allows contributions from both employer and employee, maximizing savings potential.
- -Better catch-up contributions: Unlike the SEP IRA, the Solo 401(k) allows catch-up contributions for those over 50.
- -Custodian Differences: Not all custodians offer a Roth Solo 401(k), but as of 2024 Charles Schwab does.
- -Professional Management Advantage: Research shows that professionally managed 401(k) plans can outperform self-directed ones by over 3% annually, potentially yielding 75% greater growth over 20 years.
- -Expert Guidance for Tax-Efficient Retirement: A CERTIFIED FINANCIAL PLANNER™ can help optimize your retirement strategy. Path Financial offers expertise in both pre-tax and Roth Solo 401(k) plans to help you retire on your terms.
The Role of Tax Efficiency in Retirement Planning
Having a tax-efficient vehicle for retirement is critical, particularly for small business owners that worry they won’t be able to retire—and
only a third have retirement plans in place. Self-employed individuals have many options, such as a traditional IRA, Roth IRA, SEP IRA, or a Solo 401(k), and it’s not always clear which is best. However, many small business owners delay setting up a retirement plan, often due to time constraints, limited knowledge, or worries about cost and complexity—and some never get around to it at all.
The Solo 401(k), also known as a One-Participant or Individual 401(k), is
designed specifically for self-employed individuals, sole proprietors, owner-only corporations, and independent contractors with no employees other than a spouse.
A particular benefit of the Solo 401(k) is the Roth contribution option. Like a Roth IRA, this option allows you to invest post-tax dollars that grow tax-free and can be withdrawn tax-free in retirement. And unlike Roth IRAs, Solo 401(k)s have no income limits, allowing high earners to make contributions.
In 2024, Roth IRA contributions are restricted to married couples with incomes below $240,000 (phasing out at $230,000). Solo 401(k)s impose no such restrictions.
The Solo 401(k) also
allows much higher contributions. For 2024, Roth IRA contributions are capped at $7,000 ($8,000 if 50 or older), but eligible Solo 401(k) participants can contribute both as employee and employer. Employee contributions are capped at $23,000 ($30,500 if 50 or older), with additional employer contributions up to 25% of net salary compensation up to a collective total of $69,000 ($76,500 if 50 or older).
SEP IRA versus Solo 401(k) Plans
The SEP IRA is also an option that business owners consider. Only the employer can contribute to a SEP IRA, up to 25% of compensation (20% for sole proprietors and unincorporated single-member LLCs) or $69,000, whichever is lower. However, the SEP IRA lacks a catch-up option for those 50 and over. It is also required that employers contribute the same percentage for each eligible employee. In contrast, Solo 401(k)s are available only to business owners with no employees, underscoring different applications for each account. While Secure Act 2.0 allows SEP IRAs to accept Roth contributions, few custodians offer this feature, making Roth Solo 401(k)s more accessible.
Not all custodians offer Roth contributions for Solo 401(k)s, but availability is expanding. As of January 1, 2024, Charles Schwab added the Roth feature for Solo 401(k)s, for example.
Depending on the custodian, you can hire a financial advisor to manage the investments in your Solo 401(k), adding professional oversight to align your retirement accounts with your financial goals. Studies show that professionally managed 401(k)s outperform self-directed ones by over 3% annually, net of fees, resulting in
75% greater growth over 20 years. Given the
average working life of 48 years, this difference is worth considering.
Optimize Your Retirement with Path Financial
A tax-efficient retirement strategy is key to long-term financial success. A CERTIFIED FINANCIAL PLANNER™ can help guide you. Path Financial offers expertise to help you open, fund, and manage a pre-tax or Roth Solo 401(k), helping you retire on your terms. Contact us today to learn more.
Questions?
Talk to us.
