Solo 401k When You Have Self-Employment Income

In order to pay minimal taxes when you do a backdoor Roth, you should have no balance in any other traditional, SEP or SIMPLE IRA. If you have a large balance in those accounts, you can rollover the money into an employer-sponsored plan such as a 401k or a 403b before you do the backdoor Roth.

When your employer plan has poor investment options, there’s an alternative: set up a solo 401k for yourself. Then you can rollover your traditional, SEP, or SIMPLE IRA to your own solo 401k.

What Is a Solo 401k

The IRS describes a solo 401k this way:

The one-participant 401(k) plan is not a new type of 401(k) plan. It is a traditional 401(k) plan covering a business owner with no employees, or that person and his or her spouse.

Perfect For a Micro-Business

A solo 401k is perfect for a one-person or husband-and-wife business with no other employees. The business doesn’t have to be a full-time endeavor. Nor does it need to generate a large income. I started my solo 401k when I had only a few hundred dollars a year from self-employment.

Husband-and-Wife Sole Proprietorship

If you are married and both husband and wife want a solo 401k account, the easiest setup would be to operate the business as a “qualified joint venture.”

In short, both husband and wife own the business, both materially participate in it, and you split the income and expenses. You don’t set up any LLC or S-Corp. You just file a joint return with two Schedule C’s and two Schedule SE’s as sole proprietors. You would set up one solo 401k plan with two participants.

If you have one person as the owner and the other as a W-2 employee, you would have to run payroll ($30/month at one online payroll provider). Maybe it’s OK for a larger business. It’s not worth it when your business is making only a few hundred dollars a year.

If you have one person as the owner and the other person as an independent contractor on 1099, you would have two separate businesses, and two solo 401k plans with one participant each. It’s more complicated than just having husband and wife co-own the same business.

Setting Up a Solo 401k

First get an EIN from the IRS online. Then fill out some paperwork from a solo 401k provider. I use Fidelity and I recommend it without reservation for this purpose. Fidelity has detailed getting started guide on its website. Fidelity doesn’t charge any setup or maintenance fee.

Vanguard’s solo 401k doesn’t accept incoming rollovers from IRAs. You can’t use it to enable the backdoor Roth. In addition, it doesn’t allow you to invest in lower-cost Admiral shares or ETFs. It ends up costing more than Fidelity.

Contributing to a Solo 401k

Contact your solo 401k provider for how to rollover existing assets from your traditional, SEP, or SIMPLE IRA.

Use my spreadsheet to calculate how much you can contribute from your self-employment income each year. See Solo 401k For Part-Time Self-Employment. Tax software such as H&R Block or TurboTax can calculate it too. Although it isn’t much when your self-employment income is low, I would still contribute each year when you have self-employment income. It keeps the plan active.

Investing In a Solo 401k

Fidelity lets you invest in practically anything in a brokerage account. See previous post on the best index funds and ETFs at Fidelity.

No CPA Needed

You don’t need a CPA when you run your simple business as sole proprietorship. Tax software such as H&R Block or TurboTax is fully capable of producing the necessary tax forms for your micro-business.

When your solo 401k plan assets exceed $250,000, you are required to file a Form 5500-EZ every year before July 31. It’s also a very simple form. Fidelity sends the necessary information for it every year. It takes less than 5 minutes to complete.

If you are self-employed just by yourself or together with your spouse, with no employees, a solo 401k can do everything a SEP IRA does. In many cases you can contribute more to a solo 401k than to a SEP IRA, but never the other way around. If you currently use a SEP IRA, you should consider switching to a solo 401k, especially if you want to enable the backdoor Roth.

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Comments

  1. RabbMD says

    Does your spreadsheet take into account the 0.9% ACA healthcare bill surcharge starting in 2013 going forward on income over $200,000 single and $250,000 married filling jointly going forward?

    Because there was no married vs single line I assume not. It may not effect your ability to contribute to a solo 401k and unnecessary to include as well? I am still leaning about the specifics of this surcharge as I am sure most CPAs are as well.

    • Harry says

      As I understand it, the 0.9% surcharge is a tax on the employee. The employer side still stays at 1.45%. Therefore all the calculation for solo 401k contributions referring to the employer’s portion of the self-employment tax isn’t affected by the 0.9% surcharge.

    • Harry says

      You need an EIN separate from your SSN. Just use the IRS online application. You will get one at the end of the application steps.

  2. JR says

    Thanks for this info! For some reason, I did not realize you could roll a traditional IRA into your current employer’s 401k. In my case, this would allow me to roll my IRA to my 401k and roll my spouse’s IRA into a solo 401k, and then we’d be eligible for back door Roth.

  3. Mike says

    I have a 1-man operation…have for 10+ years and use a SEP IRA. Is there any advantage to a solo 401k? My AGI ranges between $100-$150k

    Appreciate your site,
    Mike

  4. TJ says

    Hmm.. Could Fidelity roll over the ROTH portion to a ROTH IRA and the traditional portion to a Solo 401(k)?

    Seems I’m stuck with a mixed 401(k) with a 75bps net asset fee. Oh well.

    • Harry says

      Yes you can roll over the Roth portion of your 401k from a previous employer to a Roth IRA at Fidelity or elsewhere and the traditional portion to the Fidelity solo 401k.

  5. angel says

    I will be having approx 300-400 dollars of profit on my side work this year. I also have a bad 401k in an old job that i want to roll over, but haven’t done it cause Im now doing the backdoor roth.
    the question is can I open a solo 401k and contribute a minimum amount and at the same time roll over my old 401k there? I have approx 50k in the old job 401k. is that ok?

    • Harry says

      Yes that’s OK. Make sure where you are opening the solo 401k will accept the incoming rollover contribution from your old 401k. Fidelity does. Vanguard does not, unless they changed the policy recently.

    • Angel says

      Thank u so much!!
      It’s funny the things one has to do in order to be able to have a better retirement plan or to be able to do a backdoor Roth.
      The government should allow anyone contribute after tax money to a Roth regardless of income. At least that’s the way I see it

  6. TJ says

    It does seem strange that we have an income limit for ROTH’s, it’s not like it’s going to make much difference in the assets of the super wealthy with $5k/year going into a retirement account.

  7. jr says

    I have both a W2 job and a 1099 job as well. I am already maxing out my W2’s retirement 401 K plan but I am not in love with the options. Does it make sense to set up a Solo 401K for my 1099 income or just do a SEP and roll it over to a Solo 401K before I do my backdoor conversion?

    • Harry says

      Depending on how much income you get from your 1099 job, if you set up a solo 401k you can contribute to the 401k at your W-2 job only to get the match and contribute the rest to your own solo 401k, in addition to making the employer contribution from the 1099 income. It’s too late for 2013 income (you can still do a SEP for 2013 before April 15). It would be good for 2014 and beyond.

  8. UC says

    Just discovered your blog looking for help on filing the 5500ez. I have a fidelity 401k and your form is perfect. Thank you!
    Question regarding setting my wife as a partner in my business and participants in my 401k so we can double the contributions.
    I tried to figure out the partnership income split “sweet spot” given the SE penalty of 12.4% (assume income above 250k).
    You don’t happen to have a spreadsheet for that, do you? 😉

    • Harry Sit says

      If you send me these info via the contact form, I will see how I can help you.

      – The business’s net profit before any retirement plan contributions.
      – Whether the business is taxed as an S-Corp or sole prop/qualified joint venture.
      – How much employment income your wife earns outside the business.

  9. JR says

    My spouse is a sole proprietor who uses his SSN to file taxes. To open the solo 401k, he will need to get an EIN. Once he gets the EIN, which does he use on his taxes in the future? Can he keep using the SSN? Or If it’s the EIN, does that mean he will need to update his information with his customers, so that they send their 1099s with the EIN?

  10. Chan says

    Thanks for the spreadsheet calculator but how would the ROTH affect your contribution limits? I noticed it’s not included in the calculations. I was under the assumption that it’s included in the $17,500 ($23,000). My scenario for 2014 is $10,000 (457 through employer), $5,500 (ROTH) & $2,500 (Solo K-employee).

    • Harry Sit says

      Roth IRA contribution doesn’t affect the contribution limit for solo 401k. It’s not included in the $17,500 ($23,000).

  11. BB says

    What happens to solo 401K if in future you get an employee and the employee does not want to participate in 401K? Are you prevented that year from making a contribution or does the plan need to be changed/terminated?

    • Harry Sit says

      If the employee isn’t eligible (part-time working less than 1,000 hours a year), you can keep the plan. Otherwise the plan has to be changed or terminated.

  12. Victor says

    Hi! I would appreciate your insight in the following situation: If I am participating in Company A’s 401k+Profit sharing plan and max out $52k in total; at the same time open a self-employed 401k plan for a separate and unrelated consulting business, which will not allow me to defer any salary (since it’s been deferred by Company A’s 401k plan)….can I still make non-elective EMPLOYER contribution to the plan to the allowed max of $52k on this self-employed 401k plan?

    Thank you in advance!

    • Victor says

      Thank you so much for your feedback!! I went thru your page on Solo 401k and saw your spreadsheet, awesome job!! I appreciate you sharing your knowledge on these issues.

      On an unrelated note……how do you feel about a Cash Balance Plan with 401k PS? Do you feel the fees (not so nomimal at first glance in most cases) are worth the trouble? I would be interested in picking your brain on this subject if you don’t mind :)

      Thanks again!

    • Harry Sit says

      I don’t know enough about it. I only know my level of self-employment income doesn’t justify it. Something along the line of Schwab’s Personal Defined Benefit Plan can make sense (Schwab’s rule of thumb is age 50 with $250k in income). If you are in that territory it’s worth talking to the professionals.

  13. Mary says

    Thanks for sharing! My husband and I own a LLC (no other participants). He is an independent Contractor. I have a full time job with company A and max out my 401 k at my company A acc. (17,500). 20% of our LLC net income would be 30,000. Can I tuckaway pretax 30,000 into my solo 401k with our LLC?

    • Harry Sit says

      First divide up the income from the LLC between the two of you (if LLC is taxed as sole proprietor) or set the salary from the LLC (if it’s taxed as S-Corp). Then use my spreadsheet to calculate how much each person can contribute and receive contribution from the LLC. Enter the numbers for each person separately. Also note there are two tabs, one for sole proprietor and another for S-Corp. See Solo 401k For Part-Time Self-Employment.

  14. Jan says

    Can you tell me where on the tax return to report the Individual 401 K contributions?
    1. The employee 23,000 if traditional (I’m not doing this but am curious)
    2. the employee 23, 000 if ROTH ( I am doing this and assume it does not show up on tax return)
    3. The employer 20/25% (I believe this must be traditional) ) ( I believe this is form 1040, line 28)

    Thank you so much. I have reviewed the IRS publications and many sources and don’t see a clear answer as “contributions” are often referred to without specifying which type.
    Really appreciate your help!

  15. james says

    Hi harry, Im a self employed proprietor with no employees. I recently etablished a solo 401k on dec 31 2014 with merill lynch so i have not made any contributions for 2014. My income for 2014 was 102,000. My question is can i make my max contributions for the 2014 tax year as both employee and employer still before april 2015 tax deadline?

    • Harry Sit says

      For employee contributions, you had to sign an agreement with yourself on or before 12/31/2014 to say how much you as the employee wanted to contribute to the solo 401k. You can make employer contribution before tax filing deadline.

  16. DaveKY says

    I am starting a new job as an independent contractor hoping to make $250-350k. If I open a Solo 401k, can I make the employer contributions ($18k) designated as Roth contribution, and the employee contributions traditional contributions? I see above that you said Fidelity doesn’t allow Roth contributions, do you know which fund managers do?

    • Harry Sit says

      Only the other way around. If the solo 401k provider allows (Vanguard does), you can make the employee contribution ($18k) as Roth and the employer contribution (20% sole prop or 25% of S-Corp salary) as Traditional.

  17. Dave says

    Did you have to report your solo 401k account opening to your employer? If you work for a FINRA member full time this is required so I am wondering if there is any risk to your job when you open one.

  18. Paul says

    2014 is the first year I had any self employment income and I also created a solo 401(k). It’s part-time work with minimal income (a couple hundred dollars) and no expenses, and I did create my own EIN with the IRS. I am employed full-time elsewhere. Do I report my self-employment income with a schedule C? Thanks for your great blog!

  19. Chris says

    Thank you for this wonderful article. I do want to confirm a few things though:

    My wife has a EIN for some of her sporadic freelance work and we have reported in on C-EZ and SE schedules, so we are set here. So, we’d contact Fidelity and use the EIN to open a solo 401(k) with two participants (wife as owner, and myself as spouse). Next, transfer the traditional IRAs over to the solo 401(k). I’m good through here.

    Here’s where I get a bit fuzzy. I know we’ll have self-employment reportable income this year and were contributing the maximum to our day job 401ks. We’ll have to reduce our day job 401k contributions, to make room for any self-employed 401k contributions, right? Also, since the side work is sporadic, does the solo 401k need a contribution every year? Or just in the years were there is self-employment income?

    Thanks for your help.

    • Harry Sit says

      You don’t automatically become an eligible participant just by being the spouse. If you go by the qualified joint venture setup, you have to materially participate in the business. See the link to the IRS site for more info.

      You don’t have to reduce your day job 401k contributions. You can contribute to your solo 401k with only employer profit sharing contributions. See the linked article and spreadsheet on solo 401k for part-time self-employment. You don’t have to do it every year. Only in the years when you have self-employment income.

  20. Barbara says

    I mistakenly made my individual 401k contribution two weeks after my taxes were filed. The contribution was figured into the taxes. Is there a way to remedy this situation so that I don’t lose my contribution altogether? Thanks.

    • Harry Sit says

      Not sure what mistake you made. Contact your individual 401k provider and see what they say.

  21. David says

    I have an EIN for my business. However, when going through the forms to setup an Individual 401K with Charles Schwab, they also ask for a second EIN for the “Plan Tax Identification Number”. They specifically point out that this is a different EIN from the business EIN.

    I’m confused by this and can’t find great information, but some other places suggest they same thing: http://www.mysolo401k.net/ein-number/

    Basically, that I need a EIN for the business, and then a second EIN for the retirement trust that my business manages.

    Do you know anything about this? If I’ve already established my Solo 401K and used the business EIN for both identifiers, how do I correct this?

    • Harry Sit says

      If you use Schwab and Schwab wants it, I think you should just get one. I found this on the IRS website:

      “Retirement Plan Trustees should apply for an EIN for the plan’s trust in order to properly:

      * report Form 945 deposits and other income tax withholding information, and
      * provide Form W-9 to requesters of tax identification number certifications.

      Trustees should not use the EIN of the Plan Sponsor for these purposes.”

      http://www.irs.gov/Retirement-Plans/How-to-Obtain-or-Re-Establish-an-EIN-for-a-Retirement-Plan-Trust

      Schwab will use it to report distributions. I don’t know where exactly you used the business’s EIN as the plan’s EIN. If you haven’t distributed from the plan you wouldn’t have withheld taxes and filed a Form 945. The 5500-EZ form asks for the employer’s EIN in item 2b. If you put down the business’s EIN in 2b you did it correctly. The trust’s EIN in item 4b is optional. I don’t think you need to make corrections anywhere, at least not with the IRS.

    • Harry Sit says

      By the way if you currently use Fidelity or Vanguard for your solo 401k you don’t need a separate EIN for the plan because Fidelity or Vanguard acts as the trustee and they use their trust company’s tax ID when they report distributions. More on this in a new article next week.

  22. Junior says

    Great Blog! I have some part time income as an IC and I wanted to hire the wife. She she doesn’t participate in the materials of the business (just administrative activities). How would I go about actually hiring her (as a 1099) so I can make contributions to her own solo 401k? Would I still need to have payroll services for just the wife? I would love to keep it simple with the qualified joint venture but I don’t think administrative tasks would qualify her as a partner according to the IRS.

    • Harry Sit says

      Just like if she works for any other business as an independent contractor. She sends your business an invoice. Your business pays her. After the end of the year your business issues a 1099-MISC to her. She’ll be the owner of her administrative business. She will file Schedule C-EZ and Schedule SE, and pay self-employment tax. She will set up her own solo 401k plan.

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