Freelancing and the Solo 401k: How I decreased my tax bill by $25k
Freelancing restricts your retirement savings opportunities, but wait, does it?
Disclaimer: Not financial advice, not tax advice!
Freelancing vs. Full-time Trade-offs
Freelancers forgo a lot of employee benefits like medical, dental, gym perks, as well as employer-sponsored 401k plans, which offer over 3x higher contribution rates than traditional IRAs, limiting tax savings. For instance, full-time employees contributing $20,500 at a 40% tax rate can save around $8,200 in taxes yearly. Without a 401k, many freelancers just max out their Traditional IRA contribution, which is only $6k. But, that’s only because a lot of freelancers don’t know about the Solo 401k or Individual 401k! Yes, you can have all the benefits of a 401k as a freelancer, and more!
The Solo 401k
The Solo 401k or Individual 401k looks very much the same as a traditional 401k but is designed for a business owner, with no employees. Being a freelancer you don’t always think of yourself as running a business but in the eyes of the government, you are running a service business. By this interpretation, the majority of the +70M freelancers in the United States fit this definition, too. There are no age restrictions to opening a Solo 401k and all you need are an Employer Identification Number (EIN) and a provider, like e-trade, to set up the actual investment account.
Significant Tax Savings: $25k Reduction
I’ll use myself as an example for how you can reduce your tax bill SIGNIFICANTLY with the 401k.
| Item | Amount |
| -------------------------------------------- | -------- |
| My Taxable Income | $225,000 |
| Solo 401k Contribution | $61,000 |
| -------------------------------------------- | -------- |
| Taxable Income After Contribution | $164,000 |
| -------------------------------------------- | -------- |
| Taxable Rate (Assuming 40% for example) | 40% |
| -------------------------------------------- | -------- |
| Taxes Before Contribution (225,000 * 40%) | $90,000 |
| Taxes After Contribution (164,000 * 40%) | $65,600 |
| -------------------------------------------- | -------- |
| Tax Savings (90,000 - 65,600) | $24,400 |
| -------------------------------------------- | -------- |
By contributing $61,000 to a Solo 401k, I can reduce my taxable income from $225,000 to $164,000. Assuming a 40% tax rate, my tax bill decreases from $90,000 to $65,600, resulting in significant tax savings of $24,400.
Why does the Solo 401k have a higher limit than my Employer’s 401k option?
It might seem like it does and you might remember being limited to around $20k annually when you were working fulltime. But, actually, the total limits for a Solo 401k vs. your old employer’s 401k are the same, both had a limit of $61k in 2022! However, this limit is divided into two parts: the individual limit of $20,500, and the employer limit of $40,500. The employer limit is substantial, but it’s rarely maxed out. With a Solo 401k, you have access to both limits, making the overall contribution potential much higher.
Setting Up Your Solo 401k
- You’ll need to obtain an Employer Identification Number (EIN) via the IRS website. You can get one in 5 minutes via the IRS website.
- Open a 401k account with a platform of your choice: E-Trade offers a free option, while other alternatives include Solo401k.com, Fidelity, and more. Explore various providers through the links below.
- Deposit funds into the account
- Consult with your accounting professional to properly file your taxes
PS: Limits went up for 2023!
See if the Solo 401k is right for you!
If you’re a freelancer, the Solo 401k is a powerful tool for retirement savings and tax reduction. Share this information with your fellow freelancers and explore if the Solo 401k is right for you!
More info on the surprising benefits of Solo 401k’s to come :)
Links
I personally used e-trade to set mine up, it was a pretty manual and synchronous process, but it was free! Solo401k.com makes it a lot easier, plus I have a referral link ;). It also makes it easier to make use of all the 401k benefits/features, but it does have higher set-up fees!
- Get an EIN — https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online
- E-trade — https://us.etrade.com/what-we-offer/our-accounts/individual-401k
- Solo401k.com — https://www.solo401k.com/?via=daniel-francoeur
- Fidelity — https://www.fidelity.com/retirement-ira/small-business/self-employed-401k/overview
- Meet Beagle — https://meetbeagle.com/
Written for my friends and other freelancers who could be helped out significantly by using a Solo 401k.
I’ve been writing up and sending blurbs out to my friends in similar positions on how I used the Solo 401k to save tens of thousands on my tax bill. This is a summary of those blurbs!
Questions?
Email: daniel@dfranco.xyz
Twitter: @dfranco65
Additional Disclaimer:
I, Daniel Francoeur, do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.
