Solo 401(k) plans provide a powerful retirement savings option for the smallest businesses that have no employees.
When the plan only covers a business owner and their spouse, the IRS waives much of the red tape that typical 401(k) sponsors must navigate to qualify for tax advantages. After all, a business owner cannot discriminate in favor of highly compensated executives when they have no employees to begin with.
That said, business structures change over time as a business grows. Small-business clients who adopt solo 401(k)s must be advised about the rules that govern these plans — and be prepared to take action should they eventually hire a common-law employee who satisfies the plan's age and service eligibility requirements.
Solo 401(k)s: The Basics
A solo 401(k) is a traditional 401(k) plan that covers only a business owner and a spouse. In the most basic sense, the solo 401(k) operates in the same manner as a traditional 401(k)—contributions are made on a pretax basis and subject to ordinary income taxes when withdrawn during retirement.
However, these plans have their advantages due to greater administrative simplicity. One key advantage of a solo 401(k) plan is that the business owner isn't required to perform nondiscrimination testing because there are no employees to protect (non-highly compensated or otherwise).
Filing requirements are also minimal — if the plan's assets are at least $250,000 at year end, the plan is required to file an annual report on Form 5500-EZ. Plan sponsors have no obligation to delivery traditionally required ERISA Title I notices to participants.
Solo 401(k)s also allow the owner to make larger contributions each year. In 2023, the owner-employee can contribute up to $22,500 ($30,000 if the participant is 50 or older) in pretax dollars per year as an employee. Business owners are also permitted to contribute up to $43,500 to the plan as employer — for a total employer-employee contribution limit of $66,000 in 2023, without catch-up contributions, or $73,500 for those aged 50 and older.
However, employer contributions are also generally limited to 25% of compensation, up to the overall maximum of $66,000 (or $73,500, considering catch-up contributions).
Solo 401(k)s are also not required to carry "fidelity bonds" to protect participants from fraudulent acts, because solo plans are not ERISA-covered plans.
