Solo 401(k) Explained: The Ultimate Retirement Plan for the Self-Employed

By John Bowens, CISP

Imagine putting away as much as $77,500 in a self-directed IRA that will grow tax-free for the rest of your life, all while investing in cash flowing and appreciating real estate assets. In this article I explain how that’s possible with a Solo 401(k) and share the features of this account, as well as how this could potentially work for you.

What Is a Solo 401(k) and how does it work?

A Solo 401(k) is a retirement plan designed for self-employed individuals or small business owners with no full-time employees, aside from a spouse. This plan offers the same benefits as a traditional 401(k), including tax-deferred growth and the ability to make substantial contributions each year, but it is tailored for individuals running their own businesses.

The Solo 401(k) is unique because it enables you to contribute both as an employee and as an employer, maximizing your retirement savings potential. The plan provides significant flexibility with contribution limits and offers features like tax advantages and loan options that can benefit self-employed individuals looking for greater control over their retirement planning.

Here are some of the requirements for opening and contributing to a Solo 401(k):

You must have self-employment income, or W-2 income from the business entity that is sponsoring the Solo 401(k). For instance, if you are a real estate agent and you receive $100,000 in 1099 commissions, you have $50,000 in business expenses to deduct on your Schedule C, and then you report on your Schedule SE $50,000 on which you are paying your self-employment tax. This is considered earned income, which will support your contributions.

In contrast, let’s say all you have is passive income from rental properties. Unearned income and investment gains cannot be contributed to a Solo 401(k). See the IRS code governing “recurring and substantial contributions” guidelines for one-participant 401(k) plans.

Now, what if you are structured with an S-Corp election, paying yourself a W-2? This W-2 is the earned income that will support your contributions.

You can’t employ W-2 employees except for your spouse and yourself. You can employ your spouse, and they can have their own participant account under the Solo 401(k). This enables you to contribute more dollars to retirement accounts between both of you. You should speak to your tax professional to discuss increasing the earned income you are paying yourself and how to best strategize on current year and future contributions.

Solo 401(k) rollover rules: What accounts can you transfer?

Not only can you feed the Solo 401(k) through contributions and earnings on investments, you can also roll over funds from other retirement plans, as shown in the diagram below. Note that the only account you can’t roll in is a Roth IRA; however, a Traditional IRA, SEP IRA, SIMPLE IRA, 401(k), TSP, 403b, 457, and 401(k) Roth can be rolled in.

Solo 401(k) contribution limits and ways to maximize your contributions

The maximum contribution to a Solo 401(k) in 2025 is $70,000 if you are under 50, $77,500 if you are 50 and older.

Many business owners and sole proprietors are advised by their CPAs or other tax professionals to pay themselves a minimum salary or self-employed earnings to keep their self-employed earnings tax low. Keep in mind that with this approach, lower income will lower your allowed contribution to a Solo 401(k). For example, if you only pay yourself $10,000 in self-employment earnings, or S-Corp W-2, you can only contribute up to that amount.

The example in the diagram below shows a person with a $100,000 W-2 salary from their S-Corp, which allows them to achieve the maximum $70,000 in 2025 contributions. You will notice there are three categories:

1. Roth employee contribution
2. Employer pre-tax contribution
3. Post-tax contribution

Bucket #3 – the post-tax contribution: Generally, when discussing Solo 401(k)s, you only hear about the Roth bucket and the pre-tax bucket. However, there is a third bucket referred to as “post-tax employee contribution.” This can allow someone who has lower earned income, for example someone with an S-Corp who is only paying themselves, to still maximize the full contribution.

Let’s assume an account holder is making $100,000 in salary and they contribute $70,000 into the Roth Bucket. If you are age 50 or older, you can make the annual catch-up contribution, bringing the total amount to $77,500 in 2025.

What if you want to move your money to the Roth bucket? Through an in-plan conversion, you can convert the pre-tax bucket and post-tax bucket into the Roth bucket. A $70,000 contribution would then grow 100% tax-free and distributions would be 100% tax-free.

Learn more about contribution limits for IRAs, HSAs, and Solo 401(k) plans.

Another consideration: Controlled Group Rules

If you own a business with W-2 employees and a separate business with no W-2 employees, it is not as easy as just not offering a 401(k) to the company with W-2 employees, with your non-W2 employee business giving yourself a Solo 401(k). The IRS/DOL many years ago figured this out and put a stop to it with “Controlled Group Rules.”

For example, if you own 80% or more of Business A, which has W-2 employees other than you and your spouse, and then you have Business B, with no W-2 employees, you are just a single owner, you will be in a controlled group and you need to offer a 401(k) to all employees. In this case, a Solo 401(k) is not going to work and you need to look to create a multi-participant 401(k), likely with a Safe Harbor provision.

The controlled group rules go much further than this, with a four-part test that includes:

• The parent-child (subsidiary companies) relationship
• The brother/sister test (referenced in above example)
• Attribution rules
• Affiliated services

You should consult with your CPA or tax professional to perform a thorough exam and determine if you have a controlled group.

Can you self-direct a Solo 401(k)?

A Solo 401(k) is one of many types of accounts that can be self-directed. Usually referred to as a self-directed IRA, this approach offers greater control and flexibility, along with the potential for higher returns from diversifying your investments. As the “self-directed” name suggests, you are in control and can build a more diversified portfolio that includes alternative assets, like real estate and precious metals, in addition to traditional bonds or mutual funds. In addition to expanding your investment options, they also offer the potential to reduce or eliminate taxes.

Self-directed Solo 401(k) investment example

A client recently rolled over funds from a Traditional IRA into her Solo 401(k), starting with about $100,000. These funds were then deployed into a multi-family real estate partnership transaction in which her Solo 401(k) had a limited partnership interest. Shortly after, she converted to the Roth component of the Solo 401(k) so all her profits going forward would be tax-free.

Because she used a Solo 401(k) within a debt-financed real estate partnership, she has an added benefit. This is what I like to refer to as “compounding interest in the absence of taxation.” This client received her first distribution check in the amount of $1,566.99, with projections for a sale of the asset in three to four years, recognizing capital gains, all of which will flow back to the self-directed Solo 401(k) Roth component tax-free!

Self-employed individuals without an LLC, S-Corp, or C-Corp don’t have to form an entity just to have a Solo 401(k). The only prerequisite to open a Solo 401(k) is to be a self-employed person or business owner.

Discover if a Solo 401(k) is right for you

If you’re ready to start building wealth with greater flexibility, schedule a discovery with our team today.

John Bowens, CISP, is Director, Head of Education and Investor Success at Equity Trust Company.