Skip to Content

How to Maximize Roth Savings Through a Solo 401(k)

Contributor Natalie Choate examines how some self-employed workers can make the most of Roth savings later in life.

We’re continuing our theme from last month: how certain people can acquire Roth accounts at a low tax cost. In June, we looked at how salaried employees can take advantage of “designated Roth” options within their employers’ 401(k) plans. This month, we present a Roth idea for the not-quite-retired older worker who earns freelance income.

Self-Employed Individual With No Employees Tammie, age 66, is a "retired" accountant who still does a bit of accounting and tax return work for some longtime clients. She reports the income from this business on Schedule C of her Form 1040 income tax return. She has no employees; she does it all herself. Her income from this work is about $30,000 per year net of all expenses including the deduction for self-employment tax.

Operating a business enables her to adopt a “solo 401(k)” plan. A solo 401(k) plan is for a small business that has no workers other than the owner and/or his or her spouse and is accordingly not subject to nondiscrimination testing.

There are two kinds of contributions Tammie can now make to such a plan, one as “employer” and one as “employee.” Since she is self-employed, she is the contributor either way, but different limits and rules apply to the two types of contributions. I gratefully acknowledge the assistance of Denise Appleby, of Appleby Retirement Consulting, Inc., for helping me sort out these tricky limits.

The employer contribution. As "employer," Tammie can contribute up to 20% of her net income from self-employment: 20% of $30,000 is $6,000. This contribution can be made only to the pretax account--that is, the traditional type of retirement account, where contributions are tax-deductible (or, more precisely, excludible from income) and eventual distributions are taxable.

The employee contribution. As "employee," Tammie can make the type of "salary reduction" contribution that is characteristic of a 401(k) plan and other "cash-or-deferred arrangements." The salary reduction contribution limit for Tammie is $25,000 ($19,000 plus $6,000 "catchup" contribution because she is over age 50), or 100% of income, whichever is less. In Tammie's case, therefore, the limit is $25,000. She can elect to contribute this to either a traditional pretax 401(k) account or (on an after-tax basis) to a designated Roth account in the 401(k) plan--or partly to each.

Tammie’s income this year is relatively low. The salary she earned at the accounting firm has stopped. She will not take any Social Security payments or distributions from her IRA and other tax-deferred retirement plans until she reaches age 70. This is her chance to beef up a Roth account at a low income tax rate. She decides to contribute the maximum $25,000 to a designated Roth account in her solo 401(k) plan. She could, instead, exclude $25,000 from her gross income by sending that contribution to a traditional 401(k) account, but with this year being among the lowest tax-rate years she will ever have, the Roth account looks cheap.

And she can also make an “employer” contribution if she wants to. At first, it looks as though Tammie could contribute 25 percent of her net self employment income or $6,000. However, there is an overriding limit on this employer contribution: When added to her other contributions, the maximum “employer contribution” addition to all her accounts in the plan cannot exceed 100 percent of her compensation. Since she has already used up $25,000 for the designated Roth contribution, and her total compensation is only $30,000, the most she can add as a tax-deductible “employer” contribution this year is $5,000.

Drawbacks and limitations "Solo 401(k) plans" can be easily purchased on the Internet from some mass market financial institutions that are in the business of investing retirement plan money. The ease of adopting such a plan can lead to or mask some problems.

  • Not all solo 401(k) packages permit designated Roth accounts. Investigate this key feature carefully before signing up with your favorite financial institution.
  • If the business has any employees other than the business owner and/or spouse, any qualified retirement plan (whether 401(k) or "other") will have to cover all eligible employees on a nondiscriminatory basis, not just the business owner and/or spouse.
  • The limits on plan contributions, and plan administration rules in general, are highly complex. Not all limitations can be recited here; for example, if the business owner also owns, or works for, other companies, additional rules and testing may apply. For all applicable limits, I recommend consulting the resource "Employer Plan Comparison Table," published annually by IRA educator Denise Appleby (
  • The decisions are usually not as easy as Tammie's case tried to make them sound. All business owners should work with a lawyer, accountant, or financial planner who is qualified and experienced in advising business owners.
  • Finally, to adopt a 401(k) plan, the individual must have self-employment income (or W-2 wages if the business is incorporated). He or she must be operating, and working for, a business of some kind. Rumor has it that some people are adopting these mass market solo 401(k)s, and contributing to them, even though they don't have a business. This is not a proper or legal use of the solo 401(k) and will create serious tax and penalty problems for anyone who goes this route.

Roth Reminders A Roth retirement account is the greatest savings vehicle ever invented, because all investment profits (earnings) in a Roth account are totally income-tax-free if they are distributed (1) at least five years after the participant funded the Designated Roth account, and (2) when the participant is at least age 59 and a half, disabled, or deceased. The drawback of the Roth account is the cost of funding it: Contributions are not tax-deductible. That's why we look for situations (like Tammie's) where a low tax rate makes the tax cost of funding the Roth account relatively low.

Natalie Choate is an estate planning lawyer in Boston with Nutter McClennen & Fish LLP. Her practice is limited to consulting regarding retirement benefits. The new 2019 edition of Choate's best-selling book, Life and Death Planning for Retirement Benefits, is now available through her website,, where you can also see her speaking schedule and submit questions for this column. The views expressed in this article may or may not reflect the views of Morningstar.

More on this Topic