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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Individual 401ks | Save Tax While Saving Big for Retirement

Individual 401Ks, otherwise known as Solo 401Ks, are retirement plans is specifically designed for self-employed individuals and small business owners. They're great if you're eligible!

We talk through the benefits and advantages of a Solo 401K, including high contribution limits and the ability to invest in a wide range of assets.

We also cover record-keeping, plus why your tax preparer or CPA might not be up on the latest details of the plans. For us, they're tax plus lots of savings. That means they're a sweet spot!

We've got a special guest, Sean Mullaney, in to talk it through. He's written a book on the subject, called Solo 401(k): The Solopreneur’s Retirement Account.

Here's a link for more info about Sean's book:

Time Stamps:

00:00 Welcome

01:23 What are Solo 401Ks?

02:44 How much does it cost?

04:15 Investment Options

05:42 Application

08:01 Individual 401K vs SEP

12:28 Where does this apply that's unusual?

You can find out more about Sean here:

Twitter: Sean Money and Tax

YouTube: @SeanMullaneyVideos

John's firm website:

For advisors around the US:

Thanks for watching and please subscribe!


John: 401Ks are well known as retirement plans for big companies, but there are ways that a small business and even a sole practitioner can use a 401K to maximize their retirement savings. And that's what we're going to talk about on today's episode of Friends Talk Financial planning. Hi, I'm John Scherer, and I have a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois. And we've got a special guest today, who is Sean Mullaney, and he's going to introduce himself in a second, but first I'm going to tell everybody to please describe. It helps our YouTube presence, and we really appreciate it. So Sean, why don't you introduce yourself and tell us a little bit about what you do.

Sean: Thanks so much, Bridget. My name is Sean Mullaney. I'm a financial planner based in Los Angeles, California. I have my own solo firm, Mullaney Financial and Tax, and I recently released a book, Solo 401K: The Soloprepreneur’s Retirement Account, and I'm excited to talk a little Solo 401K today.

John: That's awesome. It's exciting to have you with us. Thanks so much for being here, Sean. And to actually talk to the guy who wrote the book on Solo 401K. Let's just start off by talking a little bit about what that means for people. A lot of folks know about the big company 401K plan but not so much about the solo 401K. What are the differences? How does that work?

Sean: Yeah. What we need to think about is self-employment. And that is growing by leaps and bounds, whether it's full-time folks like me who do self-employment full time or it's side hustlers. We're seeing a lot of interest in side hustlers, particularly among younger folks, but also among all ages. And what it is, is it's a 401K for when you're self-employed.

And I think people start out and say, “Wait a minute. That's a huge retirement plan. These multimillion/billion-dollar enterprises have 401K. How can I, as a solopreneur have a 401K?” The answer is that it's actually pretty simple. If you don't employ other folks, generally speaking, there are very large financial institutions that offer the Solo 401K, which essentially has very similar contribution limits to what you might see at a workplace 401K, and in some instances it could be a lot higher depending on how the math works.

John: Yeah. So one of the things that I know I talk with folks about is responding to the question, “It's for these giant companies. How can I do that?” And the other thing is, “Man, that's really expensive. I can't afford to do that.” For the 1000-employee company it probably is pretty expensive, but not so much the case with the Solo 401K, right?

Sean: That's right. So with the big plans, they have these things called antidiscrimination testing. They have to make sure that the lower compensated employees are represented in the plan in terms of contributions in a fair and equitable way vis-a-vis executives and those sorts of people. Well, on the Solo 401K, there's no one to protect. So there're no other employees that we're worried about. Now, we can have a solo 401K potentially with our spouse or our business partners, but generally speaking, if we have full time employees, we can't have a Solo 401K. So many solopreneurs have no employees, so it's not much of a gating issue.

And so, once that happens, I think the financial institutions see this as sort of a way of getting in the door, saying, “Hey, you know what, if I can get Johnny as a client and he can contribute his $22,500 every year to his Solo 401K, that’s great, but he might have his other brokerage accounts and other IRAs with us. Yeah, we don't have to charge much in fees.” And so that's what I see, in fact. So there are large financial institutions where the only fees you pay are the fees in the mutual funds themselves.

It doesn't erase those fees, but in today's world with index funds, there are a lot of low-cost investment options. And I think the approach the financial institutions are taking is: “Well, there's nobody to protect here, so we don't have that much in the way of compliance. We don't have to charge these excess fees. What we can do is just sort of say, ‘Hey, it's a way of getting people in the door, and then they'll invest with us for other products.’” So I think that's what we're seeing.

Bridget: Yeah. And one of the things that I see with Solo 401K is that when you get a regular four one k in a company, you have your list of generally 5 to 25 different investments that you can put it in, and that's it. Some of them are kind of bad. I hate to mention say this, but we look at them and roll our eyes, but it’s a totally different situation with Solo 401ks. You get whatever this brokerage house offers. So, for instance, we use Charles Schwab. Whatever Schwab does, you can put in the Solo 401K, so it opens it up quite a bit. You don't have to roll your eyes. You can buy whatever you want within the rules of 401K, but it's much broader. That's just what my point is.

Sean: Yeah. I think of it as both a feature and a bug. So the bug is HR doesn't email you on day one at work and say, “Hey, here's the 401K plan. Please set up your investment allocation.” So that's a bit of a bug. But the feature, like you're saying, Bridget, is that you get to decide. You get to decide the financial institution, the investments. You have their whole menu, generally speaking. Now, sometimes they've limited a little bit, but the limits, I find, are not very bad at all, so it's really more of a feature than a bug.

John: Yeah, I love that idea, Sean. There’re a lot of good things, but there's always something on the other side that you got to be aware of.

Bridget: One thing I would say that I caution clients with is that you want to the application process more seriously than you would with a lot of accounts. So I want people to save the application, which, again, doesn't seem like usually something you need, but just in case you hire employees and this goes from a Solo 401K to a real 401K, then you can convert the plan. There're reasons you want to be able to look at the original application and look at what your actual original plan documents are.

And typically, setting it up takes a little bit more time than with your typical account. For example, your typical account, like on Charles Schwab, it's just click, click, click, and here you go; here's your account number. With a Solo 401K, it's more. You got to put in more information and there're more questions. You kind of scratch your head a little bit. You might have to ask them a few questions. And be sure to save a copy of the application just in case. I know that's a weird. I don't say that with other stuff, but I would say that with this.

Sean: Bridget I agree with you. I sort of view it as like some of the administrative tasks of life: getting a driver's license, getting a passport, signing up for the SAT. It's not like a Roth IRA. You can set up a Roth IRA on your phone in five minutes.

Bridget: Right.

Sean: This is more like, “Hey, we got to make some decisions.” We're not splitting atoms, but, yes, it's a little more administratively complex. One decision you have to make is, do I want a Roth component in my Solo 401K? That could be the right answer or the wrong answer, depending on your wants, your needs, where you are today, where you want to be tomorrow. Some plans don't offer the Roth component.

I think eventually a lot of the plans will, but some plans don't. So you just have to shop around a little bit. Hey, if I want a Roth component, maybe I got to go look for a plan that offers it, and then when I'm in that plan portal, I got to make sure I affirmatively elect the Roth component in this plan, too.

John: Sean, we talked a little bit about 401K from the solo standpoint versus the big 401Ks. One of the things that we've seen a lot are plans for small businesses, like SEP plans, Simplified Employee Pensions, and in the old days, the pitch was low or no administrative costs. Sort of easy to use. Why is the Solo 401K a competitive alternative to those SEP and other similar plans?

Sean: Yeah, great question, John. And the reason is the Solo 401K offers two different types of contributions. One contribution is the employee contribution, which today, if you're under the age of 50, is $22,500. It's a lesser of self-employment income W-2 income, or that $22,500 number. So that's a big number. Plus, the Solo 401K offers an employer contribution, which, depending on your business structure, could be 20% or 25% of your earnings.

So those are two big numbers that can go into the Solo 401K each and every year. That's fantastic. SEP IRA. A lot of folks have had success with SEP IRA, but the problem with the SEP IRA is that it only has one type of contribution and that's the employer contribution. So say you're at $100,000 of Schedule C self-employment income, I've run the numbers, for Solo 401K, you can max out at $41,000 of total contributions.

It's about $18,500 and a little change if we're only doing a SEP IRA. So, look, if you're making a million dollars, they both can have the same limit, but if you're more typical, you're making $80,000, $100,000, $120,000, the Solo 401K limitations are going to be so much higher. And I think for that reason, for so many use cases, the Solo 401K is the better option than the SEP is today.

John: I really appreciate putting that in terms of employer and employee. If I work for a bigger company, it's a similar thing on a watered-down basis, but when we talk about that employee contribution, that's what I sign up for when my plan HR gives me the plan, and I can defer income, and I can put what I want to in it up to that $22,500 cap. And then a lot of times I get a company match. My company matches 3% or 5% or some number of my salary. That's that employer part. But in this case, I just want to make sure I heard that correctly, you can put in up to 20% or 25% of your salary. So that's where you get that big number of $42,000 or whatever exactly was, right?

Sean: Yeah, well, for about $100,000 these days, it’s about $41,000. John, you bring up a great point. A real advantage of going out on one's own is the Solo 401K employer contribution. So when you're at work, you're limited by their plan. And look, they're in a business, so they just can't give away money to their employees. So they say, “Look, we want people to save for retirement. We want to be competitive with our benefits, so we'll match dollar for dollar up to maybe 5% of salary.”

Well, that's great. $100,000 salary, $5,000 of employee contribution, that's fantastic. But when you're on your own, you're limited by two things. You're limited by your cash flow and by the IRS, the Internal Revenue Code—those limits. And the Internal Revenue Code basically says that if you're a Schedule C self-employed person below certain levels, you're basically limited to 20% of your net self-employment income.

So 20% where I come from is a lot more than 5%. You have to run some machinations with the self-employment tax, but you get to in $100,000 of Schedule C profit a little over $18,500 of employer contributions, which is almost four times what the W-2 worker at the large employer gets from their employer. So that's pretty good.

Bridget: Something I've seen is that when new clients are coming in the door, a lot of times their tax preparer hasn't told them about the Solo 401K option, and they have a SEP. And I just want to let people know that it is available, and the reason the tax preparers aren't necessarily thinking about this is that they're not necessarily up on the latest investment vehicles. And I look at this from the perspective of a Civil War buff.

And during the Civil War, germ theory had kind of been known; some people were thinking, “Oh, there're germs, so we should wash our hands,” but a lot of people objected to it, saying, “I don't need to wash my hands. I don't believe in that new stuff.” And so actually a lot of people lost limbs and died because it took 20 years to adopt germ theory. And I would say that individual 401Ks are kind of similar.

It's taken a long time for people to adapt and for the word to get out. Now the last thing we want to talk about is where does this apply the most? We talked about side hustles already, but another case is when you have a couple, and one spouse makes a lot of money, and the other person has their own business. Okay, why don't you tell us about that strategy?

Sean: Yeah, so the use case there would be one spouse W-2 worker, maybe a partner at a professional services firm, that sort of thing, where the income is in the high six figures, maybe in the low seven figures, and then the other spouse maybe has a smaller self-employment business. With the Solo 401K, you can deduct almost dollar for dollar, the entire Schedule C income of that other spouse. And considering that the higher earning spouse has kicked them into the 37% bracket, you're now getting a 37% deduction on every dollar you're putting into the Solo 401K, plus some state tax savings, potentially.

So I think that's a really good use case. There could be good use cases for single folks, too, especially for folks like us, maybe financial planners, lawyers, engineers, folks who have their own solo practices. And maybe the income is in the lower six figures. There are cases where there's this thing called the Qualified Business Income Deduction, where perhaps you make it too much, you do a traditional deductible Solo 401K contribution, you get to deduct that, and you open the door back up to be able to deduct that Qualified Business Income Deduction.

So those are some of the use cases. You mentioned the side hustlers where it's, “Hey, we've got a workplace 401K; we coordinate that with our Solo 401K, and it's a way to sort of optimize on two ends of the rope.” So there are some really good cases out there, and because they're pretty simple to set up and costs are low, it's certainly worth looking into if you have self-employment income.

John: That's great. Thanks so much for sharing this information, Sean. It has been really informative. This is Bridget Sullivan Mermel, and she runs a practice down in Chicago, Illinois. I'm John Scherer, and I run a practice in Middleton, Wisconsin. And the Solo 401K for somebody who runs their own business and doesn't have employees can be a really great thing. Sean Mullaney has been our guest here, Mullaney Financial and Tax. Sean, if people want to get in touch with you or order your new book, how do folks get in touch with you.

Sean: So you can get in touch with me three ways. I have a financial planning firm, is the website. On Twitter, I’m Sean Money and Tax, or you can go to my blog, It has links to the book, and I blog about tax and financial independence there.

Bridget: That's great. We'll make sure to get those in our show notes. And thanks again, Sean. I really appreciate it.

Sean: Thanks so much for having me, guys. I really appreciate it.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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