Solo 401(k) Annual Contribution Limits: Employee and Employer Contributions

Nov 22, 2024 | 401K, Solo 401(k), Solo Roth 401(k)

A Solo 401(k), also called an Individual 401(k), is a retirement savings plan for self-employed individuals or small business owners with no employees (other than a spouse). One of its key benefits is the ability to contribute both as an employee and as an employer, allowing for higher total contributions compared to other retirement plans like an IRA. However, it’s important to understand various nuances in terms of contribution limits and the difference between employee and employer contributions

1. Solo 401(k) Contribution Limits for 2024

For the 2024 tax year, the maximum total contribution to a Solo 401(k) is $69,000 (or $76,500 if age 50 or older due to catch-up contributions). This total includes both employee and employer contributions.

Here’s the breakdown:

A. Employee Contributions

  • You can contribute up to 100% of your earned income, up to a maximum of $23,000 for 2024.
  • If you’re age 50 or older, you can make an additional $7,500 catch-up contribution, bringing the total to $30,500.
  • Employee contributions can be made either as pre-tax contributions (to reduce your taxable income now) or as Roth contributions (after-tax, for tax-free growth and withdrawals).

B. Employer Contributions

As the employer (yourself), you can contribute up to 25% of your compensation. However, the compensation limit is capped at $345,000 for 2024 and $350,000 for 2025. Therefore, 25% of the 2024 limit, $345,000, would be a maximum of $86,250.

  • If you’re a sole proprietor or single-member LLC, your earned income is defined as your net self-employment income after deducting half of your self-employment taxes and your employee contribution.
  • Employer contributions are always made on a pre-tax basis, reducing your taxable income.

C. Total Contribution Limit

The combined total of your employee and employer contributions cannot exceed:

  • $69,000 for 2024 (or $76,500 if you’re age 50 or older).

2. Net Earnings and Self-Employment Tax Adjustments

If you’re self-employed, your net earnings and how self-employment taxes affect them are critical in determining your Solo 401(k) employer contributions.

A. What Are Net Earnings?

  • Your net earnings are your business’s profit after deducting all eligible business expenses.
  • However, the IRS requires you to adjust this amount by subtracting half of your self-employment tax before calculating your employer contribution.

B. Understanding Self-Employment Tax

  • Self-employment tax covers Social Security (12.4%) and Medicare (2.9%), totaling 15.3% of your earnings.
  • Unlike employees, self-employed individuals pay both the employer and employee portions of this tax.

The IRS allows you to deduct half of your self-employment tax when determining your net earnings for Solo 401(k) contributions. This adjustment reduces your taxable income for employer contribution purposes.

C. Adjusted Net Earnings Calculation

Here’s the formula:

  1. Start with your net self-employment income (gross income minus business expenses).
  2. Subtract half of your self-employment tax.
    • Self-employment tax = 15.3% of your net self-employment income.
    • Example: If your net self-employment income is $100,000, your self-employment tax is $15,300. Half of this is $7,650.
  3. Adjusted net earnings = Net income – half of self-employment tax.

D. Example

If your net self-employment income is $100,000:

  • Self-employment tax = $15,300.
  • Half of self-employment tax = $7,650.
  • Adjusted net earnings = $100,000 – $7,650 = $92,350.

For employer contributions:

  • Employer contribution = 25% × $92,350 = $23,087.
  • Total contribution (with max employee contribution of $22,500) = $45,587.

3. Roth Solo 401(k): Tax-Free Growth Option

A Roth Solo 401(k) is an excellent option for individuals who want to prioritize tax-free growth over immediate tax savings.

A. How Roth Contributions Work

  • Roth contributions are after-tax contributions, meaning you pay taxes upfront on the amount you contribute.
  • The contributions grow tax-free, and withdrawals in retirement are tax-free (as long as IRS requirements are met).
  • Only employee contributions can be Roth. Employer contributions must always be pre-tax.

B. Contribution Limits for Roth Solo 401(k)

  • Roth contributions are included in your employee contribution limit (up to $23,000 for 2024, or $30,500 if age 50+). This means the total of Roth Solo 401(k) employee contribution and regular pre-tax Solo 401(k) contribution should be subject to the limit.

C. Benefits of Roth Contributions

  • Tax-Free Withdrawals: Roth contributions are ideal if you expect to be in a higher tax bracket in retirement.
  • Diversification: Combining Roth and pre-tax contributions lets you balance taxable income in retirement.
  • Higher Contributions: Roth IRAs have income limits, but a Roth Solo 401(k) does not—meaning even high earners can take advantage of this feature.

D. Example: Using a Roth Solo 401(k)

If you earn $80,000 in net self-employment income:

  • You contribute $23,000 as a Roth employee contribution. This amount is after-tax, so it doesn’t reduce your taxable income for the year.
  • As the employer, you contribute $10,000 (pre-tax).
  • Total contribution = $33,000.

This strategy allows you to save part of your contributions in a tax-free account (Roth) and get a tax deduction for your pre-tax employer contributions.

4. Should You Focus on Employee Contributions, Employer Contributions, or Both?

While the contributions technically come from the same source—you—there are strategic reasons to balance employee and employer contributions:

A. Employee Contributions

  • Roth Option: Before SECURE Act 2.0, only employee contributions can be Roth, allowing for tax-free growth and withdrawals. SECURE Act 2.0, passed in December 2022, allowed an employer to match Roth 401(k) contributions directly into a Roth 401(k). This includes a Solo Roth 401(k). However, since the match is pre-tax, it will be taxed at the time of withdrawal (from this portion). Basically, this employer match, even within a Roth 401(k) account, is basically treated as a pre-tax regular 401(k). So our advice: try not to mingle both pre-tax Solo 401(k) and after-tax Solo Roth 401(k). Contribute employer match to the pre-tax 401(k) instead.
  • Catch-Up Contributions: If age 50 or older, you can add $7,500 to your employee contributions.

But if you don’t want to have a Roth after-tax contribution and are younger than 50, then you might as well just focus on the employer contributions, assuming your 25% of compensation is more than $23,000.

B. Employer Contributions

  • Higher Limits: Employer contributions let you contribute beyond the $23,000 employee limit.
  • Tax Deduction: Employer contributions reduce your taxable income.

C. Combining Both

Using both employee and employer contributions helps you:

  1. Reach the $69,000 (or $76,500) limit more efficiently.
  2. Diversify between pre-tax (employer) and Roth (employee) contributions.
  3. Optimize tax benefits based on your income and future tax outlook.

5. A Simple Strategy to Contribute Maximum Solo 401(k)

Based on the above, here is a simple strategy that will help you to decide how to make maximum Solo 401(k) contributions:

  1. Decide your total allowed employee and employer contribution limit, it should be the lesser of 25% of your adjusted net earnings and the IRS annual limit ($69,000 for 2024 (or $76,500 if you’re age 50 or older). Let’s call this amount MaxSolo.
  2. Decide how much you want to contribute to the pre-tax Solo 401(k) and the after-tax Solo Roth 401(k). The sum of these two amounts, say, R, should not exceed the IRS annual employee contribution limit. Note, this amount belongs to the combined employee contribution limit if you have other 401(k), and 403(b) contributions.
  3. Now, contribute the MaxSolo-R- Other self-employment retirement plan contributions as your employer contributions to achieve MaxSolo contribution allowed.

The Solo 401(k) Maximum Contribution Calculator implements the above strategy.

6. Key Takeaways

  • Maximize savings by contributing as both employee and employer.
  • Adjust net earnings for self-employment taxes to calculate accurate employer contributions.
  • Consider Roth contributions for tax-free retirement growth.
  • Use a mix of pre-tax and Roth contributions to balance tax benefits now and in retirement.