Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How to Fund Early Retirement With a Solo 401k
Transcript
- Lucas: So let's talk about a retirement account that most self-employed people either don't know about or don't fully use: the Solo 401. Luna: I feel like every freelancer hears about the SEP IRA, but the Solo 401 is way more powerful for early retirement. Lucas: And that's exactly why we're covering it today. The Solo 401 is designed for business owners with no employees other than a spouse. In 2026, you can contribute up to $23,000 as an employee — that's the elective deferral — plus up to 25 percent of your net self-employment income as the employer. Combined, the total limit is $69,000. Luna: Sixty-nine thousand dollars, tax-deductible. That's huge for anyone trying to front-load their retirement savings. Lucas: And here's where it gets really interesting for FIRE folks: the Solo 401 allows for a Roth option and, if your plan document permits, the mega backdoor Roth. That's where you make after-tax contributions — up to the $69,000 limit minus your other contributions — and then convert those after-tax dollars to Roth immediately. Luna: Right, so you're effectively getting tax-free growth on way more than the normal Roth IRA limit. Lucas: Exactly. And then the question everyone asks: 'How do I access that money before 59 and a half?' The answer is the Roth conversion ladder. With a Solo 401, you can roll funds into a Roth IRA, wait five years, and then withdraw the converted contributions — the principal — penalty-free. And since you already paid tax on the conversion, there's no tax bill either. Luna: But what about the earnings on those Roth contributions? Don't you have to wait until 59 and a half to access growth tax-free? Lucas: You do, unless you use the Substantially Equal Periodic Payments exception — SEPP. That allows you to take penalty-free distributions from any retirement account before 59 and a half, including a Solo 401, as long as you take at least five substantially equal payments based on your life expectancy. The catch is you have to continue those payments for five years or until you turn 59 and a half, whichever is longer. Luna: So you're locked into a withdrawal schedule. That can be a problem if your spending changes. Lucas: True, but for someone with a steady spending target, it's a viable bridge. And you can always access the Roth conversion ladder separately, which gives more flexibility. Luna: I want to run a concrete example. Say a freelance graphic designer earns $120,000 per year. How would she use a Solo 401 to retire at 45? Lucas: Great example. So she makes $120,000 in net profit. She can contribute $23,000 as the employee — that's the elective deferral, which can be traditional or Roth. Then as the employer, she can contribute 25 percent of her net earnings, which is about $24,000. That's $47,000 total. She has room for another $22,000 in after-tax contributions to hit the $69,000 cap, which she can immediately convert to Roth via the mega backdoor. Luna: So in one year, she's put $69,000 into retirement accounts, most of it either tax-deductible or growing tax-free. That's a massive head start. Lucas: She does that for, say, 15 years, earning 7 percent annually, and she'd have about $1.8 million. At a 4 percent withdrawal rate, that's $72,000 per year — more than enough to live on if she owns a home and has no debt. Luna: But she's 45. How does she actually get that $72,000 out? Lucas: She'd start the Roth conversion ladder in her last working year. She converts, say, $72,000 from her traditional Solo 401 to a Roth IRA each year. She pays income tax on that conversion, but since her income drops to zero after retiring, her tax rate is very low. Then after five years, she can withdraw those converted dollars penalty-free. Meanwhile, she uses the SEPP exception on a smaller account to cover the first five years. Luna: So the SEPP bridges years one through five, and then the ladder kicks in. That's a solid plan. Lucas: Exactly. And the Solo 401 makes it all possible because it lets her save so much more than a SEP IRA, which only allows employer contributions up to 25 percent of income — capped at $69,000 in total, but without the employee deferral or the mega backdoor. Luna: Right. A SEP IRA wouldn't let her do the Roth conversion ladder either, because SEP IRAs don't have a Roth option. So the Solo 401 is really the only game in town for maxing out tax-advantaged space as a self-employed person. Lucas: And if you have a spouse who works for the business, they can also participate. That doubles the limits. A couple could potentially save $138,000 per year. Luna: That's wild. So what are the downsides? There must be some. Lucas: The main one is administrative hassle. You need a written plan document, and you have to file Form 5500-EZ once the account exceeds $250,000. Also, not all brokerage platforms offer the mega backdoor Roth feature. You have to check with providers like Fidelity, Vanguard, or Schwab — and some only allow it with a custom plan. Luna: And if you accidentally hire an employee, you lose eligibility. The Solo 401 is strictly for solo businesses or those with only a spouse. Lucas: Correct. If you bring on a part-time employee who works more than 1,000 hours per year, you have to include them in the plan, which complicates things. At that point, a SEP IRA might be simpler. Luna: Let's talk about the Roth option a bit more. Why would you choose Roth contributions over traditional? Lucas: If you expect to be in a higher tax bracket in retirement, Roth makes sense. For early retirees who plan to live on low taxable income, traditional contributions give you a deduction now, and you pay low taxes on withdrawals later. But the mega backdoor Roth is almost always worth it, because you're contributing after-tax dollars that grow tax-free — and you can access the converted amount after five years. Luna: So the mega backdoor Roth is basically a way to supercharge your Roth savings beyond the normal limits. Lucas: Exactly. And it's one of the few legal ways to accumulate a large Roth balance quickly. For someone aiming for early retirement, that tax-free growth is gold. Luna: I want to mention one more thing: the Solo 401 can also take loans. You can borrow up to $50,000 or half your balance, whichever is less, and pay yourself back with interest. That could be another bridge if you need funds before 59 and a half. Lucas: Good point. But loans have risks — if you leave the job or the business fails, the loan becomes a taxable distribution. So I'd use that as a last resort. Luna: Fair. So for our listeners who are self-employed or thinking about starting a side hustle, the Solo 401 seems like the best retirement vehicle for early retirement. What's the first step? Lucas: Open one at a brokerage that supports the mega backdoor Roth. Fidelity and Schwab are good options — they offer low-cost index funds and will walk you through the plan setup. Then decide your contribution strategy: how much traditional versus Roth, and whether you want to do the after-tax conversion each year. Luna: And don't forget to set up automatic contributions. It's easy to leave money on the table if you're not disciplined. Lucas: Absolutely. Treat it like a bill. Pay yourself first.