Imagine that you are a sole proprietor with a high income and you’re looking for a way to maximize your retirement savings while reducing your taxable income. You’ve heard about SIMPLE IRAs and SEP IRAs, and you used to contribute to a 401(k) when you had a corporate job. Did you know that it is simple to set up your own 401(k) and you can contribute up to $69,000 to it in 2024 ($76,500 if over age 50)? Introducing the individual 401(k)!  

Individual 401(k)s are also known as solo 401(k)s, solo-Ks, single-Ks, self-employed 401(k)s, uni-Ks, and one-participant Ks. This type of plan is like a traditional 401(k) covering business owners with no other employees. The plan can cover the business owner’s spouse. It is also possible for the business to have employees, but they cannot be full time as defined by the plan document.  

Individual 401(k)s are easier than traditional 401(k)s to set up and administer; allow for the maximum amount of retirement plan contributions in a defined contribution plan; can allow for loans of up to 50% of the plan value up to a $50,000 maximum; and can accept rollovers from other retirement plans like IRAs, traditional 401(k)s, and 403(b)s. Another stupendous benefit is that the individual 401(k) can accept both Roth (after-tax) and traditional (pretax) employee contributions, which allows for greater flexibility of contribution type depending on the business owner’s tax situation.  

There are a few steps that you need to take to start maximizing the benefits of an individual 401(k).  

Steps:  

1. Set up the individual 401(k) plan.  
2. Appoint a plan administrator.  
3. Find a financial institution to hold the plan’s investments.  
4. Calculate allowable contribution amounts.  
5. Make contributions to the plan.  
6. Invest the plan contributions.  

Setting Up the Individual 401(k)

The first step toward making contributions to an individual 401(k) is creating the actual plan. This requires the business owner or plan administrator to complete a basic plan document, an adoption agreement, account applications, and other paperwork. This process has been simplified for individual 401(k)s and is handled in tandem with the plan administrator or financial institution that will hold the plan’s assets.  

Appointing a Plan Administrator

Plan administrators have the fiduciary duty of taking care of the administrative responsibilities and ensuring the plan is operating according to the plan document. This could include completing and maintaining the plan’s adoption agreement, establishing accounts for the business owner, filing annual tax reports, and calculating contribution amounts. The business owner can choose to fill this role or outsource it to a firm, like Compass Retirement Group in New Hampshire, that specializes in retirement plan administration.  

Finding a Financial Institution

Once you have the plan established, you will need to find a financial institution that allows you to set up individual 401(k) accounts that you can make contributions to. Key considerations that you’ll want to look at when opening the accounts are the fees, account minimums, investment options, trading costs, and plan features. Fidelity offers a simplified process for setting up individual 401(k) plan documents and accounts with no account fees and no minimums. Schwab, Vanguard, and E-Trade also have individual 401(k) account options.  

Calculating Contributions

A business owner may make contributions to an individual 401(k) as both an employee and the employer. The process for determining the maximum contribution for each is dependent on the type of business structure. The chart below shows the maximum contribution amounts for each contribution type.  

Determining Earned Income

The first step is to determine the amount of compensation or earned income that the calculation is based on to ensure that you make the appropriate contribution amounts for both the employer and employee contributions. As mentioned above, this depends on the type of business and entity. 

• Sole proprietorship: Net profit on Schedule C of IRS Form 1040.  

• Partnership or LLC taxed as a sole proprietorship: Ordinary business income on Schedule K-1. 

• S corporation, C corporation, or LLC taxed as a corporation: Wages paid to the business owner that would be represented on Form W-2. 

Employee Contributions

Employee contribution calculations are handled differently depending on the business type as described below.  

• Sole proprietorship, partnership, or LLC taxed as a sole proprietorship: An adjustment for half of the self-employment tax must be made to calculate the maximum allowable employee contribution. This number is calculated by multiplying the net profit or ordinary business income by 7.65% (1/2 of 15.3%).  

• Example: Steve, age 40, is a self-employed business owner who reports his business earnings on Schedule C of IRS Form 1040. In 2024, his net profit was $15,000. Although Steve would be able to make up to a $23,000 employee contribution to his individual 401(k), he does not have the income to support it. The maximum contribution he could make would be $15,000 minus half of the self-employment tax of $1,147.50, for a total limit of $13,852.50.  

• S corporation, C corporation, or LLC taxed as a corporation: Wages paid to the business owner represented on Form W-2 are all countable toward elective deferrals that the employee can make toward the maximum contribution amount, and no adjustments need to be made.  

Employer Contributions

Employer contribution calculations are also handled differently depending on the business type as described below.  

• Sole proprietorship, partnership, or LLC taxed as a sole proprietorship: Up to 25% of earned income can be contributed as employer contributions, but with two adjustments. Half of the self-employment tax must first be subtracted from earned income before the calculation is made. Further, the 25% figure is reduced to a maximum of 20%, because for each dollar that is being contributed as an employer contribution, the earned income is being reduced by another dollar. Because this is a circular calculation, the effective maximum contribution amount is about 20% of earned income after the adjustments for self-employment tax and the contribution itself.  

• Example: Bob, age 55, is a sole proprietor with $100,000 of net profit reported on his Schedule C. He has an individual 401(k) and wants to maximize his contributions to the plan for 2024. He first maximizes his employee elective deferrals to the plan of $23,000 and $7,500 for $30,500 total. To calculate his employer contribution, he subtracts half of the self-employment tax ($7,065) from $100,000 for a starting point of $92,935. He then multiplies $92,935 by 20% for a maximum employer contribution of $18,587. His total employer and employee contribution is $49,087 ($30,500 + $18,587). To check the calculation: $100,000 less $7,065 SE tax deduction – $18,587 retirement contribution = $74,348 x 25% = $18,587. 

• S corporation, C corporation, or LLC taxed as a corporation: Up to 25% of compensation as defined by the plan. This is a straightforward calculation because no adjustments need to be made.  

Total Contributions

For all business types, the total contribution amounts in 2024 are limited to $69,000, or $76,500 if the business owner is 50 or older. Since the employee contribution is only limited to 100% of earned income, it makes sense to start by maximizing that first and then make employer contributions if there is sufficient earned income to support them.  

Roth (After-Tax) vs. Traditional (Pretax) Contributions 

Employee contributions can be made to either a Roth (after-tax) or traditional (pretax) account. Employer contributions must be made to a traditional (pretax) account. Deciding which type of account to contribute to largely depends on your individual tax situation, and it is best to consult with your tax advisor for this decision. Starting in 2026, the Secure Act requires that catch-up contributions for solo 401(k)s be made to the Roth solo 401(k) if the individual earned more than $145,000 in the prior year in that job. 

The basic difference between a Roth 401(k) and a traditional 401(k) is that the Roth 401(k) is funded with after-tax contributions while the traditional 401(k) is funded with pretax contributions. With a Roth 401(k), you pay taxes today on your earned income in return for tax-free withdrawals in retirement. Traditional 401(k) contributions are tax deductible today, but withdrawals are taxed in retirement.  

As mentioned before, one of the great benefits of the individual 401(k) is that you have the flexibility to contribute to both types of accounts, which isn’t the case with SEP IRAs and SIMPLE IRAs.  

Making Contributions  

Once you calculate how much you can contribute to the individual 401(k), you can start making contributions immediately. Employee and employer contributions can be made throughout the year if there is enough income to support them. Sole proprietorships, partnerships, and LLCs taxed as sole proprietorships or partnerships can make both employee and employer contributions up to the tax filing deadline (April 15, or October 15 with an extension). For an S corporation, a C corporation, or an LLC taxed as a corporation, the employee deferrals must be elected by the end of the tax year (December 31) and made by January 15 of the following year. Employer contributions can be made up to the tax filing deadline (March 15, or September 15 with an extension).  

Investing

After you’ve made the contributions to the accounts, the final step is to select investments. These can be mutual funds, ETFs, individual stocks or bonds, or other assets allowed by the financial institution to be held in the account. Which investments you choose depends on many factors, including risk tolerance, taxes, age, and personal preference. You can make the investment decisions on your own or consult a Certified Financial PlannerTM.  

Other Retirement Options for Self-Employed Individuals

While the solo 401(k) is a powerful retirement savings tool, it’s not the only option available for self-employed individuals. You can read about other savings options here. 

Summary

If you are a business owner and want to boost your retirement savings, you should strongly consider the individual 401(k). If, after reading this blog article, you want to learn more about the individual 401(k) and how it can supercharge your retirement, please reach out to our team. We can talk to you about how the individual 401(k) fits into your other retirement savings, investments, tax situation, and financial plan.