Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How a Solo 401k Supercharges Early Retirement Savings
Transcript
- Lucas: So you're freelancing on the side, maybe you make twenty, thirty grand a year from consulting or a small online business. And you think, well, that's nice extra income, but it's not enough to really move the needle on retirement savings. That's the assumption I want to challenge today. Luna: Because a solo 401k can let you put away way more than that side income itself, right? Lucas: Exactly. And not just a little more—potentially tens of thousands more, in a tax-advantaged account, every year. The key is understanding how the contribution math works when you're both the employee and the employer. Luna: Before we dive too deep—and this ties right into what you're saying—a quick honest thing. A handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what funds making this many of these episodes ad-free. Lucas: Yeah, it's a small group, but it makes a huge difference. Keeps us independent, no sponsors to answer to. So if you've gotten value from the show, that's the one place to support. Appreciate it. Luna: Alright, back to the solo 401k. So Lucas, set the baseline—what's the max someone with a regular W-2 job can put into their 401k this year? Lucas: For 2025, the employee deferral limit is $23,500. If you're fifty or older, you get an extra seven thousand five hundred catch-up, so $31,000 total. But that's just what you can defer as an employee. Your employer can also contribute—up to 25% of your compensation, but the total from both sides can't exceed $70,000 for 2025, or $77,500 with catch-up. Luna: Right, and that $70,000 cap is per person, per employer. So if you have a day job with a 401k and a side business, you might think you're capped at one limit. Lucas: But that's the beauty—the solo 401k is a separate plan for your self-employed business. You can max out your day job 401k at $23,500 and then also contribute to a solo 401k for your side gig, but with a twist: the $23,500 employee deferral is shared across all your 401k plans. So if you've already deferred $23,500 at your day job, you can't make additional employee deferrals into the solo 401k. Luna: Okay, so that part is capped. But what you can do is make an employer profit-sharing contribution from your side business, up to 25% of your self-employment income, and that doesn't count against the employee limit. Lucas: Correct. And here's where it gets wild: the solo 401k's total contribution limit is the same $70,000—but that's per plan. So between your day job 401k and your solo 401k, you could potentially receive up to $70,000 in employer contributions from the solo plan alone, as long as your side income supports it. But there's a more common, powerful strategy. Luna: The mega backdoor Roth. Let's talk about that. Lucas: Yes. Some solo 401k providers allow after-tax contributions—not Roth, but after-tax—which are separate from the employee deferral limit. You can contribute up to the overall plan limit of $70,000 minus any employer contributions. So if your side business nets you, say, $50,000, you could put in 25% profit share as the employer—$12,500—and then as the employee, you could contribute after-tax dollars up to $70,000 minus $12,500, so $57,500. But you're limited by your actual earned income. Luna: And that after-tax money can then be converted to Roth, tax-free, if the plan allows in-plan Roth conversions. That's the mega backdoor. Lucas: Exactly. So let's make this concrete. Say you're a software engineer earning $150,000 at your day job. You max your 401k there: $23,500 employee deferral, plus maybe a 5% match, so total maybe $31,000. On the side, you do freelance consulting and net $20,000 after expenses. With a solo 401k, as the employer you can contribute 25% of $20,000—that's $5,000. Then as the employee, you can make after-tax contributions up to the $70,000 limit minus that $5,000, so up to $65,000. But you only have $20,000 of side income, so realistically you could contribute the remaining $15,000 as after-tax, then convert it to Roth. Luna: So on just $20,000 of side income, you've put $20,000 into tax-advantaged retirement accounts—$5,000 pre-tax profit sharing, $15,000 after-tax converted to Roth. That's a 100% savings rate on that income. Lucas: And if you're under fifty, that $20,000 is on top of the $23,500 you deferred at your day job. So total retirement savings from both plans: $43,500, all tax-advantaged. And if you're over fifty, you get catch-up contributions too. Luna: But is this really worth it for someone with just a small side hustle? There's setup cost, ongoing recordkeeping, and the risk of making a mistake. Lucas: Fair question. The solo 401k isn't for everyone. If your side income is under five or ten thousand a year, the juice might not be worth the squeeze. But once you're consistently netting fifteen grand or more, the tax savings can be significant. And the setup isn't that hard—you can open one at Vanguard, Fidelity, or Schwab in under an hour. The key is making sure the provider allows after-tax contributions and in-plan Roth conversions if you want the mega backdoor. Luna: So what's the catch? There has to be one. Lucas: The main catch is that if you have any employees—including your spouse—you generally have to cover them too. So if your side business has part-time help, it gets complicated. Also, the solo 401k requires an annual filing once your plan assets exceed $250,000. And you need to be careful not to commingle your day job and side business contributions. Luna: And if you decide to shut down the side business, you have to terminate the plan and roll the assets somewhere else. It's not a set-it-and-forget-it account. Lucas: True. But for many freelancers, consultants, and gig workers who are serious about early retirement, the solo 401k is the most powerful tool available. It can turn a modest side income into a massive retirement contribution runway. Luna: So if someone's listening and thinking, 'I have a side hustle, should I open a solo 401k?', what's the first step? Lucas: First, check if your day job 401k is already maxed. If not, prioritize that, because the employer match is free money. Second, estimate your net self-employment income for the year. If it's consistently above fifteen thousand, it's worth it. Third, pick a provider that offers the features you need—Roth, after-tax, and in-plan conversions if you want the mega backdoor. Vanguard's solo 401k doesn't allow after-tax contributions, so you'd need to look at Fidelity, Schwab, or a provider like Solo 401k or My Solo 401k Financial. Luna: And you can make contributions up until your tax filing deadline, including extensions, for the prior year. So you don't have to decide by December 31st. Lucas: Right. That's a huge advantage. You can file your taxes, see exactly what your net income was, and then make the contribution accordingly. And the profit-sharing contribution is calculated on that net income after deducting half of self-employment tax. Luna: One thing I want to highlight: if you're aiming for early retirement, especially before age 59 and a half, you need a strategy to access those funds without penalty. The solo 401k has the same early withdrawal rules as a regular 401k—you can take loans, or use substantially equal periodic payments, or roll to a Roth IRA and then access contributions after five years. Lucas: And don't forget the Roth conversion ladder. If you're retiring early, you can convert solo 401k funds to a Roth IRA over time and then withdraw the converted amounts after five years. That's a whole other episode, but it's a classic early retirement move. Luna: Alright, so let's summarize: solo 401k lets you contribute both as employee and employer, with a total cap of $70,000 per plan in 2025. If you have a day job, you can still contribute as employer from side income. And with after-tax contributions and in-plan Roth conversions, you can get a lot more into Roth than you'd think possible. Lucas: The bottom line: don't dismiss your side hustle as 'not enough to matter' for retirement. With a solo 401k, that side income can punch way above its weight. And for early retirees, that extra tax-advantaged space can be the difference between retiring at 45 or 55. Luna: And if you're looking for a place to start, check out the links in the show notes—we'll have a comparison of providers and a simple checklist to get your solo 401k set up. Lucas: Good episode. Next time, we'll talk about how to handle the solo 401k if you eventually hire your first employee—because that changes everything. Luna: That sounds like a real problem worth solving. See you next time.