A solo 401k lets a self-employed person with no employees contribute twice, once as the employee and once as the employer, for a combined cap nearly 10 times the IRA limit. If your business earns more than you can shelter in an IRA, open one and fund the employee side first.
An IRA’s contribution limit stays the same whether your business nets $30,000 or $300,000.
A solo 401k grows with the business because you fund it from two sides. As the employee, you can defer all of your compensation until you hit the annual 401k limit. As the employer, you can add a contribution that works out to about 20% of net self-employment earnings for a sole proprietor. By the IRS’s current limits, the employee side alone is more than three times the IRA cap, and the combined ceiling is nearly 10 times it.
Say you net $50,000 from freelancing. IRS Publication 560’s worksheet puts the employer side at roughly $9,300, more than a full year of IRA contributions, before you defer a dollar as the employee. A SEP IRA offers only that employer side, which is why a solo 401k lets you put in at least as much and usually more.
The plan is for a business owner with no employees other than a spouse. If you also have a 401k at a day job, your employee deferrals to both plans count toward one limit, so the employer contribution does more of the work.
Open a solo 401k at a brokerage and set up regular deferrals from your business income. Figure the employer contribution with Publication 560’s self-employed worksheet when you do your taxes, since it depends on your final net earnings. Once the plan holds $250,000 or more at the end of a year, you’ll generally have to file Form 5500-EZ.
Treat the IRA limit as the floor for your retirement savings, not the ceiling.
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