Why an Owner-Only 401(k) Plan Might Be Your Best Possible Retirement Option

Even if you're a one-person shop, you still have options that can help you save for retirement. In fact, your position as the owner/employee of your company gives you access to an owner-only 401(k) plan, a distinct option for retirement savings.

Building a retirement account for your non-working years has never been more important. America's looming retirement crisis could mean poverty for millions of elderly people, forcing many to keep working, regardless of age. A 2023 Retirement Confidence Survey by the Employee Benefit Research Institute (EBRI) shows both worker and retiree confidence that they will have enough money to live comfortably on throughout retirement dropping to levels not seen in a half decade. Sixty-four percent feel at least somewhat confident, with only 18% feeling very confident.

Saving wisely during your career can make all the difference. Fortunately, sole proprietors can take advantage of an owner-only 401(k) to help them prepare for their golden years.

What's an owner-only 401(k) plan?

An owner-only 401(k) is an employer-sponsored retirement savings plan that may also be referred to as:

• Solo 401(k)
• Solo-k
• Uni-k
• One-participant k

The owner-only 401(k) is built to serve businesses with no employees. If you are a sole proprietor, or share ownership with other individuals but don't have rank-and-file workers, this plan may be a great fit.

A key feature of an owner-only 401(k) plan is the ability to maximize your contributions: You are not limited by employee contribution restrictions under the actual deferral percentage, or ADP test as you would be by a traditional 401(k) plan serving additional employees.

Look at a 401(k) plan as an investment — perhaps a sounder investment than your business. The money you contribute will be eligible for distribution at age 59½, regardless of your current position. You're also collecting interest on money that is growing and working for you. A back-up plan for the golden years is usually a smart choice.

Who is eligible for owner-only 401(k) plans?

Owner-only 401(k) eligibility is limited to the following:

• The plan participant must be the business owner who has no employees.
• The business owner's spouse may also participate if they are employed by the business.
• Business owners may be self-employed independent contractors, sole proprietors, corporations, limited liability companies (LLCs), and partnerships.
• The participant can be any age and make any amount of income.

How can I set up an owner-only 401(k)?

You can open a solo 401(k) plan at most financial institutions. In general, you'll need the following to set up your plan:

• Your Employer Identification Number
• A completed application and plan adoption agreement, available from your provider
• Choose the investments offered by your provider (mutual funds, index funds, exchange-traded funds, individual stocks and bonds)
• You may also need to complete certain paperwork as required by the Internal Revenue Service (IRS), such as Form 5500-SF if you have $250,000 or more in the plan at the end of the year

Your plan must be established by Dec. 31 if you want to make a contribution this year. See below for more details about contribution deadlines.

Can I cover my spouse under my owner-only 401(k) plan?

Although self-employed 401(k) plan participation is limited to the business owner, the owner's spouse may participate in the plan, as long as they earn income from the business. Given that both spouses can participate, this plan offers a great opportunity for a family to significantly increase their contributions toward retirement savings.

Owner-only 401(k) plan contributions

An owner-only 401(k) plan has the same rules and conditions as any other 401(k) plan. You can make contributions to the plan as both a business owner and an employee.

The following rules regarding owner-only 401(k) contribution limits are as follows:

• Elective deferrals up to 100 percent of compensation ("earned income" in the case of a self-employed individual) up to the annual contribution limit:
  • $23,000 in 2024, or $30,500 if age 50 or over; plus employer non-elective contributions up to 25 percent of compensation as defined by the plan, or, for self-employed individuals, an amount determined by a special computation.
  • Total contributions to a participant's account, not counting catch-up contributions for individuals age 50 and over, cannot exceed $69,000 for 2024. Contributions are tax-deductible.

When are contribution deadlines for a one-person 401(k)?

You must establish an owner-only 401(k) plan by the last day of your business tax year, but no later than Dec. 31 of the year for which contributions will be made. For 2024, you must have established your one-person 401(k) plan by Dec. 31, 2023 and make your employee contribution elections by the end of the calendar year.  Employer contributions must be made by the due date of your business tax return plus extension.

Can I contribute to other retirement accounts?

There are no restrictions on having multiple retirement accounts, including an owner-only 401(k) plan, but contribution limits apply across accounts. For example, if you have an owner-only 401(k) and also participate in an employer-sponsored 401(k) plan at another job, the limit for the year applies to cumulative contributions across all plans you have, not each individual plan. As an employee, you can contribute a maximum of $23,000 (or $30,500 if you're 50 years of age or over) across all of your 401(k) plans in 2024.

Owner-only 401(k) tax benefits

There are many owner-only 401(k) tax benefits, one of the most notable being the flexibility to choose either a traditional or Roth setup — meaning you can decide when you fulfill your tax obligations.

If you choose to set the plan up as a traditional 401(k), you will make contributions with pre-tax dollars, which reduces your taxable income for the current year. Contributions continue to grow tax-deferred, and are taxed as income when you take distributions after retirement.

Alternatively, setting up an owner-only 401(k) as a Roth account means you make contributions with after-tax dollars. Contributions grow tax-free and any distributions taken after retirement are tax-free.

Tax penalties for an owner-only 401(k)

Depending on when you withdraw money from your owner-only 401(k) and which type of account you withdraw from, you may be subject to taxes and penalties if you make distributions before age 59 ½.

Early withdrawals from a traditional solo 401(k) will incur a 10 percent penalty as well as any applicable income taxes on the amount you withdraw. Early withdrawals from a Roth solo 401(k) aren't subject to a 10 percent penalty, but you pay a penalty and income tax on earnings.

Exceptions for owner-only 401(k) early distribution penalties may include:

• Medical expenses that exceed 10 percent of your adjusted gross income
• Permanent disability
• Certain military service
• A Qualified Domestic Retirement Order (QDRO) issued as part of a divorce or court-approved separation

Additional benefits of owner-only 401(k) plans

In addition to giving you a secure retirement savings vehicle, an owner-only 401(k) plan allows you to borrow from your account if you need quick access to funds — as long as you specify that you want the plan to contain a loan provision.

If business is slow, you don't have to contribute to the plan every year. You can decide from year to year how much you're able to contribute, or if you need to temporarily suspend your 401(k) contributions.

Is an owner-only 401(k) right for my business?

While an owner-only 401(k) is a great option if you have no employees, it's not your only choice for retirement accounts. Consider other plans such as SEP IRAs, profit-sharing plans, and SIMPLE IRAs, each of which has their own contribution limits, tax advantages, and other benefits.

Today's 401(k) plans can fit into the scopes and budgets of small operations — even solo enterprises. The benefits of a retirement plan are numerous to both workers and company owners. As a sole proprietor, you fill both categories, so consider taking advantage of this unique position for maximizing retirement contributions.