Stash Your Cash in a Solo 401(k)

Congratulations! You finally got motivated and found a side hustle you enjoy and pays well. The checks are rolling in and it’s time to decide what to do with all this extra money.

Maybe you got the side job to pay off student loans or save for a down payment on a house. Those are both great uses of the income.  If you’re working the side job to get yourself one step closer to financial independence there is an account you shouldn’t pass up:  the solo 401(k)

solo 401k, self employed retirement accounts
May the cash be with you

What is a solo 401(k)?

A solo 401(k) is a IRS approved retirement plan for anyone who is self-employed.  Like the normal 401(k) you have through your main job, this account allows tax deferred savings on any 1099 (independent contractor) income.

You can have more than one 401(k)

I know what you’re thinking.  You already max out your elective contributions to your employer’s 401(k).  Even better your job offers profit-sharing and they max out those contributions for a total of $55,000/year.  Surely you can’t create a second 401(k) to stash even more money away.

Although it is true that the IRS limits elective employee contributions to $18,500/year, it is also true that the IRS limit on profit-sharing contributions is per employer.  If your main job is working as a W2 employee and your side hustles are as an independent contractor you have two employers.  That means you could save up to an additional $55,000/year in a second account.

abundance bank banking banknotes
You’re going to need a bigger briefcase

More Savings = Less Taxes

The more money we make, the more taxes we owe.  It is not unusual for a physician to lose more than 40% of their side job income in federal and state income taxes.  The thought of losing almost half your income in taxes certainly decreases the motivation to work harder.

As I mentioned in How to hide $215,000 from the IRS, you should take advantage of every tax deduction Uncle Sam gives you.  Every dollar you put into a solo 401(k) is one less dollar you are taxed on.  Maxing out your employer 401(k) and a solo 401(k) can save you tens of thousands of dollars on income taxes every year.

How much can you contribute?

white black business calculator

An independent contractor can contribute 20% of their net business income in profit-sharing contributions.

Net business income = total side hustle income – self employment tax

Like I discussed in You Don’t Need a LLC, you may not owe much self employment tax on this income if you’ve already maxed out your social security taxes from your main job.  Your self employment tax is limited to Medicare taxes (2.9%)

If you made $100,000 as an independent contractor and you already maxed out your social security taxes from your main job, your solo 401(k) profit-sharing contribution would be:  (100,000 – 2,900) x 0.20 = $19,420

Use a solo 401k to consolidate other accounts

Maybe you worked before med school and have an old employer 401(k) you don’t know what to do with.  Then you finished residency and you moved your hospital 401(k) into a rollover IRA.  Then you left your first attending job after 18 months and you have retirement money parked in their 401(k) as well.  As these accounts multiply, keeping track of all your investments gets more complicated.  To make matters worse, some of these plans probably have poor investment options or pricey expense ratios.

Many custodians will allow you to rollover all of these different accounts into your solo 401(k).  Now you’ve consolidated your money under one roof and you have complete control of how it is invested.

Solo 401(k) clears the path for backdoor Roth IRA

Most physicians make too much money to directly contribute to a Roth IRA.  Luckily, there is no income limit on converting a traditional IRA into a Roth.  There is one catch, however – if you have old traditional rollover IRAs you will be forced to convert them to a Roth as well, resulting in a huge tax bill.

If you move your rollover IRAs into your solo 401(k), you have now cleared the path for a lifetime of tax-free backdoor Roth contributions.  In fact, some physicians will start a side hustle purely to generate 1099 income so they can create a solo 401(k) to clear the path for backdoor Roths.  Hustles come and go, but backdoor Roths last forever.

Solo 401(k) for asset protection

Assets held in a solo 401(k) are protected from creditors in bankruptcy court.  Although laws vary from state to state, most states protect these assets from non-bankruptcy creditors (malpractice or other civil suits) as well.  Every dollar you put in a solo 401(k) is another dollar you are protecting from liability.

Where to Invest

There are more than a dozen solo 401(k) providers out there, but I would recommend sticking to the mainstream ones.  There are many factors to consider when picking a provider including fees, whether they accept rollovers, whether you can take out 401(k) loans and do they allow Roth 401(k) options.

If being able to accept rollovers is important to you, avoid Vanguard.  *This might be the only time you ever hear me say something negative about Vanguard.

vanguard

Vanguard solo 401(k)

Fees: $20 per Vanguard fund per year

Accepts rollovers:  No

Loans allowed: No

Roth option: Yes

fidelity

Fidelity solo 401(k)

Fees:  $0 if you invest in Fidelity mutual funds.  $4.95 per trade for stocks or ETFs.

Accepts rollovers:  Yes

Loans allowed:  No

Roth option:  No

 

schwab

Schwab solo 401(k)

Fees:  $0 if you invest in Schwab ETFs.  $4.95 per trade for non-Schwab ETFs.

Accepts rollovers:  Yes

Loans allowed:  No

Roth option:  No

etrade

E-trade solo 401(k)

Fees:  $6.95 per trade on all stocks and ETFs.  $4.95 per trade if you make more than 30 trades/quarter.

Accepts rollovers:  Yes

Loans allowed:  Yes

Roth option:  Yes

 

 

 

Want to learn more?

There are plenty of great resources out there to learn about the solo 401(k).  I would recommend the Bogleheads Solo 401(k) Wiki or the IRS Retirement Plans for Self-Employed People website.  You can also check out the White Coat Investor’s Rules For Having More Than One 401(k).

 

 

What do you think?  Does a solo 401(k) make sense for your side hustle income?  What advice would you give physicians looking to start a self-employed retirement account?  Share your thoughts and comments below.

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19 thoughts on “Stash Your Cash in a Solo 401(k)

  1. Thanks for putting this together SHS. A solo 401(k) is at the top of my to do list if my side hustle (my blog) ever generates any significant income.

    Uncorking my nerdy side for a moment, I took my kids to see the new Han Solo Star Wars movie last weekend, and I thought it was great, much better than the new trilogy movies.
    -Ray

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    1. Even a small solo 401(k) can be worth the effort if it clears the path for a backdoor Roth. A $100 profit sharing contribution could lead to over $330,000 in backdoor Roths for you and a spouse over a 30 year span!

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  2. A solo 401K is great because of the large sum you can potentially put away. I used to have one in Vanguard then transferred it to a self-directed 401k. Now I have more investment options (and risks).

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