What Are the Tax Benefits of an Individual 401K?

40.8 million Americans are self-employed. And many are supplementing their current income by tapping into the gig economy with freelancing or gigs like driving for Uber.

There are many benefits to being self-employed. Working your own hours, avoiding office politics, and making your own decisions are just a few of them. But when you work for yourself, you don’t get to enjoy a corporate retirement plan. Preparing for your retirement is entirely up to you.

However, as you’re about to learn, this is good news. The answer to this problem is an individual 401k, which allows entrepreneurs and people who are self-employed to save for their own retirement.

The best part? There are some excellent tax benefits available if you do it the right way.

What is an Individual 401k?

You probably already know how a 401k works. You contribute as much as you can (or as much as you’re allowed) each year. The power of compound interest can turn $5000 a year into $1m at retirement.

But an individual 401k is designed specifically for people who are self-employed, or entrepreneurs with only themselves and their spouses as employees.

These are also referred to as:

  • Solo 401ks
  • One-person 401ks
  • Self-employed 401ks

To be eligible, you simply need to be claiming some income from self-employment on your tax return. What’s great about this, is you don’t need to be in full-time self-employment. Even if you work full-time and freelance on the side, or drive for Lyft on the weekends, you can use an individual 401k for your extra income.

The Tax Benefits You Should Know About

There are a few key tax benefits that make a solo 401k well worth it if you’re self-employed. Here are some of the most important:

Higher Maximum Contributions

The maximum pretax contributions are much higher with an individual 401k compared to the SEP-IRA.

For example, if you earn $50,000 net, the most you can contribute to the SEP-IRA is $9,293 a year. But if you choose a solo 401k, you can contribute a massive $31,293- a $22,000 difference.

With a regular 401k, both the employee and the employer make contributions. But when you’re self-employed, you serve both roles. The individual 401k recognizes this, allowing you to make both contributions.

Contributions are Discretionary

When you’re self-employed, your income may fluctuate wildly from year-to-year, particularly when you’re first getting established. With an individual 401k, there are no mandatory yearly contributions.

This means you can better manage your cash flow, contributing the maximum amount when you have a great year, and decreasing this (or contributing nothing) if your business takes a downturn.

Loans are Allowed

One of the biggest benefits is you can take a loan of up to 50% of the value of your plan’s benefits, or $50,000, whichever is lower. No other plan allows you to take a tax-free loan. And this is a big deal considering people who are self-employed often have extremely variable incomes.

While many people believe taking a loan from your 401k is a bad idea, it can actually be much better financially than a bank loan. Not only are the “interest rates” much lower, but you’ll have up to five years to pay it back. All principal and interest go right back into your retirement savings.

Realistically, in this case, you’re borrowing your own money from yourself. This is usually a much better idea than using credit cards or taking out a personal loan.

After-tax Contributions

A Roth account allows you to make your contributions after tax. If you think you’ll be in a higher tax bracket when you retire, this will save you a good deal of money. Individual 401ks help remove the savings’ barriers imposed by IRA accounts.

Many people who are self-employed find that they have issues when they want to get a mortgage. That’s because they have used so many tax deductions that their income is considered too low to qualify.

When you pay tax at the time that you’re contributing to your 401k, you don’t need to pay it when it’s time to retire. This means that when you’re planning for retirement, you can accurately prepare, knowing that Uncle Sam has had his share.

For this reason, it will often make sense to pay the tax on your contributions. Keep in mind that the “employer” contribution needs to be paid on a pre-tax basis, so you’ll need to work this out accordingly.

No Income Tax

There’s no question- there are many benefits to being in a low-income bracket. An everyday individual 401k (not a Roth) is tax-deferred. That means you don’t need to pay income tax on your earnings or plan contributions until it’s time to withdraw.

The choice of whether to pay the tax now or later is up to you. But the fact that you can choose based on your individual situation is why individual 401ks are such a great choice.


You can rollover funds into your solo 401k. These can be from another retirement plan like a SEP or IRA, or even your 401k from a previous employer.

Sometimes it just makes sense to have all of your retirement funds in on place- especially if you’ve recently left full-time employment to go it alone.

The tax benefit here? Unlike the SEP-IRA, the individual 401k isn’t considered when it’s time to evaluate the pro-rata cost in order to perform a Roth conversion. This can be complicated, so you may want to hire a certified public accountant to help with the math.

The Bottom Line

When you’re self-employed, your retirement falls entirely on your shoulders. And thinking about your financial future now can be the difference between retiring in style, and working until you’re 75 or 80.

If you’ve been putting off your retirement planning, take the first step today. Look into your options for an individual 401k. Remember: Even a small contribution each year will be compounded into a much larger sum down the line.

Want to learn how we can help you plan for your retirement? Get in touch today and let’s talk.


Gilbert, AZ

1176 E Warner Rd #115
Gilbert, AZ 85296
(888) 899-2566

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