Each December, I run the numbers to see how much more I can contribute to my Self-Employed 401k plan, aka Solo 401k or Individual 401k. Fidelity, Vanguard, and Dinkytown (used below) have calculators to figure out contribution limits to various types of retirement plans (Solo 401k, SIMPLE IRA, SEP IRA, Profit Sharing Plan).
In general, as long as your income isn’t too high ($275,000+) and you aren’t deferring salary from another workplace retirement plan, the Solo 401k will allow you to defer the largest percentage of your business income. This is because the Solo 401k allows you defer as much as $18,500 (2018) in salary as an employee as well as 20% of your net self-employment income as an employer (both sides of your business) up to $55,000 total (2018). For example, if your income from your side business was $5,000 and you had no other salary deferral elsewhere, you could put 100% of that into a Solo 401k. (If you are age 50 or over, you can also add a $6,000 catch-up contribution to the salary deferral limit.)
Here are sample numbers for a $50,000 net income to your self-employed business. This assumes you are a sole proprietorship or an LLC taxed as a sole proprietorship. The math for a single-owner corporation is slightly different.
At $50,000 net business income, you can defer 56% annually ($27,793). This is exactly $18,500 more than if you went with the SEP-IRA.
Here’s the comparison for a $100,000 net income to your sole proprietorship.
At $100,000 net business income, you can defer 37% annually ($37,087). Again, this is exactly $18,500 more than if you went with the SEP-IRA.
Now, the Solo 401k does require a bit more paperwork. For example, you will need to file the IRS Form 5500-EZ separately every year once your Solo 401k assets exceed $250,000 to avoid steep IRS late penalties. SEP-IRAs have no such annual requirement. Therefore, if you don’t intend to take advantage of the higher contribution limits of a Solo 401k, I would consider sticking with the SEP-IRA. But if your goal is a high savings rate and maximum tax-deferred funds, look into the Solo 401k. I would compare the offerings from Vanguard, Fidelity, and Schwab. (Mine is at Fidelity.)
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