Latest / The Financial Freedom Podcast with Fexingo: Quitting Your Job, Living Off Investments, Independence / How Early Retirees Use a Solo 401k to Cut Taxes
Transcript
- Lucas: So Luna, we've talked a lot about withdrawal strategies for early retirees, but what about the accumulation side? I mean, what if you're still earning some income after you leave your job? That's where the solo 401 comes in. Luna: The solo 401? That's usually for self-employed people, right? But how does that help an early retiree? Lucas: Exactly. If you're doing any freelancing, consulting, or even running a small online business after you retire, you can set up a solo 401. It lets you make contributions as both the employee and the employer, and those contributions are tax-deductible. Luna: So you're essentially creating your own retirement plan, and it lowers your taxable income in the year you contribute. That sounds like a win-win. Lucas: It is, but there are limits and rules. For 2026, the elective deferral limit is $23,500, and if you're over 50, you can add a $7,500 catch-up. Plus, as the employer, you can contribute up to 25% of your net earnings from self-employment, but the total combined can't exceed $70,000, or $77,500 with the catch-up. Luna: That's a lot of tax-deferred space. But how does that compare to a traditional IRA? Lucas: Well, a traditional IRA for 2026 has a contribution limit of $7,000, plus a $1,000 catch-up. So the solo 401 gives you much more room to shelter income. Luna: And it's not just for people who are full-time freelancers, right? Even a small side gig counts? Lucas: Absolutely. If you have any self-employment income, you can open a solo 401. Even if it's just a few thousand dollars a year from a side hustle, you can make contributions based on that income. Luna: So what's the strategic move for someone who's in early retirement but still earns some money? Lucas: The key is to use it to fill up your lower tax brackets. Say you're retired and your only income is from dividends and some part-time consulting. You can make a significant contribution to a traditional solo 401, which lowers your taxable income, potentially keeping you in a lower bracket. Luna: And you could also choose a Roth option, right? That would be after-tax contributions but tax-free withdrawals later. Lucas: Right. But for early retirees, a traditional contribution might make more sense because you need to manage your taxable income to keep your ACA subsidies or qualify for other tax credits. It's all about the trade-offs. Luna: So it's not just about saving for retirement, it's about tax planning in the present. Lucas: Exactly. And the solo 401 can be a cornerstone of that strategy. But you have to be careful about the deadlines. You have to set it up by December 31st to make contributions for that year, but you actually have until the tax filing deadline, usually April 15th, to make those contributions. Luna: That's a useful detail. So you can see how much you owe in taxes and then decide to contribute to lower that bill. Lucas: Precisely. It gives you flexibility during tax season. And there's another advantage: unlike a SEP IRA, a solo 401 allows for loans, which can be handy if you need short-term cash without a taxable distribution. Luna: But wait, we covered margin loans and HELOCs before. How does a solo 401 loan compare? Lucas: It's different because you're borrowing from your own retirement account, and the interest you pay goes back to yourself. The catch is that if you leave your job or the plan terminates, the loan becomes due quickly, which can be a problem. Luna: So it's a bit risky for early retirees who might not have a stable employer anymore. But the tax benefits are compelling. Lucas: Definitely. And speaking of what we're doing here, if you're finding these conversations helpful, you can support the show at buy me a coffee dot com slash fexingo. It's how we keep things ad-free and independent. Luna: Yeah, every little bit helps, and we appreciate it. But back to the solo 401 — what about the paperwork? Is it a pain? Lucas: Not too bad, actually. You can open one at most major brokerages like Fidelity or Vanguard. They handle the admin, and you just have to file a Form 5500-EZ once your account exceeds $250,000. Luna: That's a threshold most people won't hit. But what about if you have employees, even a part-time one? Does that complicate things? Lucas: Yes, it does. If you have any non-spouse employees, you can't use a solo 401. You'd need a regular small business 401 plan, which comes with more compliance and costs. So the solo version is really for solo entrepreneurs, or you and your spouse if they also work in the business. Luna: Got it. So it's perfect for the typical early retiree who does a bit of consulting or has an Etsy shop. Lucas: Exactly. And one more thing: if you have both a solo 401 and a traditional IRA, you can consolidate them? Not exactly, but you could roll over your IRA into the solo 401 to enable a backdoor Roth, which can be another tax strategy. Luna: That's advanced, but it shows how flexible this account is. So what's the one thing you want listeners to remember? Lucas: If you have any self-employment income, even a few thousand dollars, a solo 401 lets you save a lot more for retirement and cut your current tax bill. It's a powerful tool that many early retirees overlook. Luna: And it's not that complicated to set up. I'm almost tempted to start a side gig just to use one. Lucas: Ha, that might be the best reason to start a side hustle. Before we wrap up, just to reiterate, if you enjoy the show, consider supporting us at buy me a coffee dot com slash fexingo. It keeps us going. Luna: And we truly appreciate it. So, next time you do your taxes, think about whether a solo 401 could be part of your early retirement toolkit. Lucas: Absolutely. That's it for today. Thanks for listening, and we'll catch you in the next episode.