Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Solo 401k for Self-Employment Income
Transcript
- Lucas: You’ve officially retired early, you’ve got your portfolio humming, you’ve got your withdrawal strategy dialed in — and then a former colleague calls with a consulting project that pays fifteen thousand dollars. Luna: Right, and suddenly you’re not just living off investments — you’ve got earned income again. But do you even have a retirement account anymore? Lucas: Exactly. That’s the gap a lot of early retirees hit. You left your employer plan behind, you’re not eligible for a new 401k, and you might think you’re stuck with an IRA and its seven-thousand-dollar limit for 2026. Luna: But if you have any self-employment income — consulting, freelancing, a little Etsy shop, whatever — you can open a Solo 401k. And the limits are shockingly high. Lucas: Let’s start with the mechanics. A Solo 401k — also called an individual 401k — is for a business owner with no full-time employees other than a spouse. You wear two hats: employee and employer. Luna: And those two hats get separate contribution buckets. Lucas: Yes. As the employee, you can defer up to twenty-three thousand dollars in 2026 — that’s the same as a regular 401k. And if you’re fifty or older, there’s a seven-thousand-five-hundred-dollar catch-up on top. Luna: But the real leverage is the employer profit-sharing piece. You can contribute up to twenty-five percent of your net self-employment income. Lucas: And when you combine both buckets, the total can’t exceed sixty-nine thousand dollars for 2026 — or seventy-six thousand five hundred with the catch-up. That’s almost ten times the IRA limit. Luna: So if you net, say, a hundred thousand from consulting, you could defer twenty-three thousand as the employee and then another twenty-five percent as the employer — that’s twenty-five thousand — for a total of forty-eight thousand. Lucas: You’ve got the math right. But there’s a nuance: the twenty-five percent employer contribution is based on your net earnings from self-employment after deducting the self-employment tax and the employee deferral itself. So it’s actually twenty-five percent of your adjusted net profit. Luna: It ends up being about twenty percent of your gross profit in practice, right? The IRS worksheets guide you through it. Lucas: Exactly. And it’s still a huge amount of tax-advantaged space. But here’s the part that’s especially relevant for early retirees: you can choose a Roth Solo 401k. Luna: That’s a game-changer if you’re in a low tax bracket because your investment income is modest. You pay taxes on the contribution now and then all growth is tax-free. Lucas: And in early retirement, your marginal rate might be ten or twelve percent — that’s historically low. Locking in that rate on Roth contributions is smart if you expect higher taxes later or if your side income grows. Luna: Plus you can split your contributions between pre-tax and Roth. You don’t have to pick one. Lucas: Right. You could put the employee deferral into Roth and keep the employer profit-sharing pre-tax. That’s a common strategy — you get the tax deduction on the profit-sharing, and the Roth piece grows tax-free. Luna: Let’s talk about the practical side. Where do you open a Solo 401k? Lucas: Vanguard, Fidelity, Schwab — all the major brokerages offer them. They’re straightforward to set up. You need an Employer Identification Number from the IRS — that’s free and takes five minutes online. Luna: And you have until the tax filing deadline — including extensions — to make contributions for the prior year. So even if you didn’t plan ahead, you can still catch up. Lucas: That’s a huge advantage over an IRA, where you’re locked into April fifteenth. With a Solo 401k, if you file an extension, you have until October fifteenth to fund it for the previous year. Luna: What about the investment options? I hear some people say Solo 401ks can be restrictive. Lucas: At the big brokerages, you’re limited to their menu of mutual funds and ETFs — which is still plenty. If you want self-directed control — real estate, private equity, crypto — you’d need a Solo 401k at a specialty custodian. That’s more expensive and more paperwork. Luna: For most early retirees, the standard brokerage version is sufficient. You can buy low-cost index funds just like in your IRA. Lucas: One more feature that’s underappreciated: the loan provision. You can borrow up to fifty thousand dollars or half your balance, whichever is less, from your Solo 401k. You pay the interest back to yourself. Luna: That’s helpful if you need a short-term bridge for a big expense — like a roof replacement or a used car — without selling investments and triggering a tax event. Lucas: Exactly. And since you’re self-employed, you’re both the plan administrator and the borrower. The paperwork is minimal. Just make sure you set up a written loan policy when you create the plan. Luna: Now, what about the downside? There’s a big one if you accidentally hire someone full-time. Lucas: The moment you have a non-spouse employee who works more than a thousand hours a year, you lose the Solo 401k. You’d have to convert to a regular 401k with all its compliance and nondiscrimination testing. So it’s really for solopreneurs or couples. Luna: And if your side gig is very small — say you earn five thousand dollars from freelance writing — is it worth the hassle? Lucas: At that level, a SEP IRA might be simpler. You can contribute up to twenty-five percent of your net earnings — about twelve hundred fifty dollars on five thousand — without any employee deferral or annual filing requirement. But the Solo 401k has a Roth option and loan capability, so if you think the income will grow, it’s worth setting up. Luna: And if you have a SEP IRA, it can interfere with the backdoor Roth IRA because of the pro-rata rule. The Solo 401k doesn’t — as long as you keep the pre-tax balance in the Solo 401k and don’t roll it into a traditional IRA. Lucas: That’s a crucial point for anyone doing a Roth conversion ladder in early retirement. You want to keep your traditional IRA balance as low as possible. A Solo 401k at Fidelity or Schwab can accept rollovers from old 401ks, which helps clear your traditional IRA for the backdoor Roth. Luna: So it’s not just a contribution vehicle — it’s also a parking spot for old retirement money. Lucas: Exactly. And once your balance exceeds two hundred fifty thousand dollars, you have to file Form 5500-EZ annually with the IRS. It’s a simple one-page form, but if you miss it, the penalties are steep — up to two hundred fifty dollars a day. Luna: That’s a gotcha. Set a calendar reminder. The deadline is July thirty-first, and there’s no extension. Lucas: So to wrap the mechanics: Solo 401k is a powerful tool for early retirees with any self-employment income. High limits, Roth optionality, loan access, and no interference with backdoor Roths. The only real friction is the annual filing once you’re over the threshold. Luna: Okay, this is a small ask, but if this episode helped you think about a decision differently — or if you’re the kind of person who actually sets up a Solo 401k after hearing this — and it felt worth a coffee to you, that link is buy me a coffee dot com slash fexingo. No pressure, just if it was useful. Lucas: Yeah. Listener support keeps this show ad-free, and we appreciate it. Alright — so the takeaway: if you have a side gig, don’t leave retirement savings on the table. A Solo 401k is simpler than you think, and the limits might surprise you. Luna: And if you’re already maxing that out, maybe it’s time to grow that side gig. Because the cap is sixty-nine thousand dollars for 2026, and that’s a lot of consulting hours.