Solo 401(k)s Explained: A Guide for Self-Employed Business Owners

Solo 401(k)s Explained: A Guide for Self-Employed Business Owners

When you’re self-employed, planning for retirement can feel overwhelming. Without a company 401(k) to fall back on, it’s up to you to create your own strategy. One of the most powerful (but often misunderstood) options is the Solo 401(k).

This plan gives entrepreneurs, freelancers, and small business owners the ability to make large tax-advantaged contributions, even with no outside employees. Here’s what you need to know for 2025.

Who Qualifies for a Solo 401(k)?

A Solo 401(k), sometimes called a “one-participant 401(k)”, is available if you have no common-law employees. That means you can’t have unrelated full-time staff on payroll, but you can include your spouse if they also work in the business. As long as your spouse earns compensation, they’re eligible to contribute under the same rules, effectively doubling how much the household can save each year [IRS – One-Participant 401(k) Plans].

Contribution Limits for 2025

What makes the Solo 401(k) unique is that you contribute in two ways: first as the “employee” of your own business, and second as the “employer.” In 2025, the employee deferral limit is $23,500, with an additional $7,500 catch-up for those age 50 or older.

On top of that, the employer side allows contributions of up to 25% of compensation. However, there’s an important nuance. If you pay yourself W-2 wages through an S-corp, you can use the full 25%. But if you’re a sole proprietor or partner, the IRS defines “compensation” differently: net earnings reduced by half of your self-employment tax and by the contribution itself. Because this creates a circular calculation, the IRS publishes a rate table in Publication 560, which shows the effective cap works out to about 20% of adjusted net earnings [IRS – Publication 560].

Example: How the 25% Becomes 20% for Sole Proprietorships

Maria is a self-employed consultant with $150,000 in net earnings from her sole proprietorship.

• Employee deferral: She can contribute $23,500 (plus $7,500 if 50+).
• Employer contribution:
  • Self-employment tax = 15.3% × $150,000 = $22,950.
  • Half of that is deductible ($11,475), leaving $138,525 as the adjusted base.
  • Using the IRS rate table, the maximum employer contribution is 20% of $138,525 = $27,705 (not $37,500).

Total for 2025: $23,500 + $27,705 = $51,205 (before catch-up).

If Maria’s spouse also works in the business and earns compensation, they can contribute under the same rules, potentially allowing the household to save well over six figures each year.

Roth Contributions

One of the biggest advantages Solo 401(k)s have over SEP IRAs is the ability to make Roth contributions. Many providers allow you to designate employee deferrals as Roth, meaning you contribute after-tax dollars today and enjoy tax-free withdrawals in retirement. Employer contributions, however, must always go into the pre-tax side.

Deadlines and Paperwork

To set up a Solo 401(k), the plan must generally be adopted by December 31 of the year if you want to make employee deferrals for that year. Under SECURE 2.0, sole proprietors have a special exception: they may adopt a plan by their tax filing deadline (without extensions) for their first plan year.

Once your plan balance exceeds $250,000, you’ll also need to file an annual Form 5500-EZ with the IRS [IRS – One-Participant 401(k) Plans]. While this sounds intimidating, many providers simplify the filing process.

Solo 401(k) vs. SEP IRA

Business owners often compare Solo 401(k)s with SEP IRAs. Both allow significant contributions, but the Solo 401(k) typically offers more flexibility.

The key takeaway: a Solo 401(k) often allows higher contributions at lower income levels, especially when combined with employee deferrals. SEPs, while easier to set up, don’t offer the same Roth flexibility or loan options.

Pros and Cons

The main advantages of a Solo 401(k) are the high contribution limits, Roth deferral potential, and the ability for spouses to join in. On the downside, there’s more paperwork than with IRAs, and if you eventually hire non-family employees, the plan must be converted to a traditional 401(k).

How SWP Helps Business Owners

At Strategic Wealth Partners, we regularly work with entrepreneurs and self-employed professionals who want to maximize their retirement savings. Our role is to clarify the IRS rules, ensure contributions and deductions are calculated correctly, and help maintain a plan that grows with your business.

If you’re self-employed and wondering whether a Solo 401(k) fits your situation, click the link to schedule a 30-minute Zoom with one of our advisors.